Can I take £500 out of my pension to protect the rest from a tax raid?

Charlene Young from the wealth manager AJ Bell offers her advice

Charlene Young

Monday September 29 2025, 5.00am BST, The Times

Can you help with regard to my defined contribution stakeholder scheme? I am retired so am no longer paying into the pension and it is sitting there waiting to be taken. I’ve claimed my state pension and have another pension that pays me about £12,000 a year.

I’m worried about the 25 per cent tax-free lump sum being under threat in the budget in November. My pot is worth £200,000. Am I any worse off if I take 1 per cent tax-free now, leaving the other 24 per cent to be taken at a later date but securing the existing tax-free percentage? If a change happens, will it take effect immediately, or could I jump on it in November and take action the day after a potential announcement?
Mike, address supplied

Charlene Young replies

You can usually take up to 25 per cent of your pension tax-free, up to a maximum of £268,275 for most people. The state pension does not affect your lump sum allowance, but you would have used some of your allowance when you accessed your other pension savings and took a tax-free lump sum. How much depends on when and how you accessed that scheme. Your pension firm or an adviser should be able to help you to work out how much of your lump sum allowance you have used.

You could take up to £50,000 tax-free from your £200,000 stakeholder pot, assuming that you have enough lump sum allowance remaining. To do this you’d have to move the £150,000 balance (the remaining 75 per cent) into an income option such as a drawdown product or an annuity.

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I don’t believe that the 25 per cent tax-free cash lump sum will be reduced. The chancellor is more likely to reduce the lump sum allowance cap. Any changes could take effect immediately or could be deferred, such as to the start of the new tax year.

The traditional tax-free cash option is officially known as a “pension commencement lump sum”. I loathe jargon, but this is useful because it confirms that the lump sum needs to be taken upfront before you choose an income option for the balance. In other words, the only way to lock in the whole 25 per cent for certain now is to access the whole fund. The 25 per cent tax-free amount would be paid to you and the balance used to give you an income.

If you instead chose to access a smaller chunk of your pot, this would not lock anything in now but leave more of your fund in the pension wrapper, shielded from tax. For example, if you “crystallised” £80,000, £20,000 would be paid out as tax-free cash and £60,000 would go into an income option.

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If you chose drawdown, these funds could pay you an income as and when you chose, or nothing at all. You’d still have £120,000 left uncrystallised, and any further tax-free cash you could take would depend on what these funds were worth when you come to access them, as well as your remaining lump sum allowance.

If you are approaching 75, that could influence your decision. Under existing rules, anything left in your pension pot will usually pass tax-free to your beneficiaries if you die before 75. Once you turn 75, withdrawals made by your beneficiaries are subject to income tax at their marginal rate. This includes tax-free cash you didn’t take in your lifetime.

If you decide you want to press ahead and withdraw your tax-free lump sum, you should consider what you’ll do with the money. If you plan to stash it in cash and investments, make sure you do so as tax-efficiently as possible. Interest and dividend income outside Isas or pension wrappers will be taxed, if it is above the personal savings allowance (which is £1,000 a year for basic-rate taxpayers) and the dividend allowance of £500 a year.

There’s a huge benefit in taking proper financial advice. It will come with a fee but it can add value by helping you to understand what decision is best for your circumstances and what to do in the event of changes.

• Read money advice and tips on investing from our experts

Speculation about the future of the tax-free lump sum causes untold damage to people’s retirement plans. It is within the chancellor’s gift to commit to preserving one of the most well-known and understood benefits of pension saving. Without this reassurance I fear that the rumour cycle will never end, and people will continue to make a once-in-a-lifetime decision with their pension pot out of fear, rather than basing their choices on what is in the best interests of their long-term plans for retirement and making sure they don’t outlive their money.

Charlene Young is a pensions and savings expert at AJ Bell

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