Savers in their droves were panicked into pulling tax-free cash out of their pensions before the Budget for fear of a clampdown on the perk.
Rumours of a raid were finally quashed some weeks before the Budget, but that came too late for some as once you take your lump sum the decision is irreversible.
People over 55 can withdraw 25 per cent of their pension tax-free up to a £268,275 cap.
There was a rush to access this money over fears the maximum could be slashed to £100,000 or even lower, according to pension companies and financial advisers.
For some, taking the cash could pay off, especially if they planned to do so anyway in the next year or so and want to spend the money for a specific purpose – paying off debt, such as a mortgage, or carrying out home renovations.
Also, some savers are pulling out cash to give away to family members following last year’s announcement that unspent pensions will be liable for inheritance tax from April 2027.
If you gift money away and survive seven years it typically falls outside of the inheritance tax net – although money experts warn you should not do this if it harms your own retirement.
Others who had no specific financial goal in mind will be looking at the new stack of cash in their bank or savings account and wondering what to do now.
Some savers are pulling out cash to give away to family members following last year’s announcement that unspent pensions will be liable for inheritance tax from April 2027
A big risk is that you can miss out on investment growth under the tax protection of a pension in future. This could leave you thousands of pounds worse off. Another is that if you try to put the money back in your pension, you could fall foul of strict rules.
Gary Smith, senior partner at wealth managers Evelyn Partners, says: ‘Taking tax-free cash without a plan can turn a useful benefit into a tax headache. Having taken funds out of a tax-protected growth environment, it’s important to protect lump sum cash from tax and inflation.’
Here are some options to ensure you make best use of your lump sum – and the pitfalls to avoid.
Where to put the cash
Chances are you initially had your lump sum transferred to a current or a savings account. You might be tempted to keep it in an ordinary savings account or Isa at a good rate of interest, but it is still likely to be eaten up by inflation.
Historically, returns from investing have also far outstripped interest on cash savings, so if you have no plans to spend the money in the next five-plus years then just letting it sit there is likely to leave you worse off in the longer run.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: ‘It may be tempting to take the cash and leave it in your bank while you decide what to do with it.
‘However, if it’s too easily accessible, you risk frittering it away over time. You may also see your purchasing power nibbled away at by inflation.’
If you are dead set on keeping your lump sum in savings, or have firm plans to spend it in the next few years, make sure you get as much of it as possible into an Isa at a top rate.
You can find the best savings rates at thisismoney.co.uk/save.
Bear in mind that if you are under 65 the cash Isa limit will be slashed to £12,000 from April 2027.
You might need to spread your lump sum across multiple accounts so it is protected in full if your savings provider goes bust.
The Financial Services Compensation Scheme protects deposits up to £85,000, rising to £120,000 from December 1. Six-month temporary high balance cover will rise from £1 million to £1.4 million.
Get shot of mortgage?
If you made a rushed decision to withdraw tax-free cash, you might not be at the right point in your mortgage deal to overpay substantially or pay it off entirely.
It might be worth stumping up an early repayment charge but you would have to do careful sums on this to determine if it makes financial sense or if you’re better waiting to the end of the term.
Smith says: ‘Someone halfway through a five-year fixed loan, for instance, might have limited overpayment options.
‘Four years is potentially a long time to hang on to a substantial lump sum, and tax-efficient cash savings options might be limited.
‘Those who do need to park their cash for a few years will need to keep a close eye on tax exposure, especially as the relatively short timeline might rule out some investment options.’
Gift the money early
With pensions becoming liable for inheritance tax from spring 2027, many families are considering the size of their estates and whether to make gifts now.
If you survive seven years after making a gift, it automatically becomes free of inheritance tax.
It’s otherwise levied on a sliding scale – starting at the full whack of 40 per cent if it’s within the first three years.
You can gift £3,000 a year, plus make unlimited small gifts of £250, free from inheritance tax.
You can also give away as much as you like every year so long as you give it on a regular basis and from income rather than capital.
It also can’t impact your own standard of living.
Smith warns that if you are gifting out of surplus income you need to be careful, as you can’t take your tax-free cash, stick it in a bank account and gift it gradually from there.
If you do it will be seen as a gift from capital, not income. He suggests the ‘canny option’ for regular gifting from a lump sum would be to fund the pension of a child or grandchild, which while probably still subject to the seven-year rule would be tax efficient.
He adds: ‘The patchwork quilt of gifting rules around inheritance tax can be tricky to navigate without advice, so we would always recommend consulting an expert, especially when withdrawing funds from a pension to gift when income tax could be an issue.’
Invest money again
If you want to stay invested, look to use up your £20,000 annual Isa allowance as far as possible.
‘In a stocks and shares Isa your money still has the potential to grow and it will be shielded from capital gains and dividend tax. Any income can also be taken tax- free,’ says Morrissey.
‘Investing outside these vehicles could leave you vulnerable to tax bills that eat away at your long-term savings.’
Smith says Isas are naturally often the first port of call for idle tax-free cash, and couples can make sure they use both sets of allowances.
‘If they have used up Isa allowances, individuals can fund a general investment account, but must be aware that after steep cuts in recent years the annual dividend and capital gains allowances are not generous – at £500 and £3,000 respectively – and it takes careful management to make the most of your allowances every year.’
Don’t put cash back in
Do not think you can just stick your lump sum back into your pension or a different one again.
There are rules to stop you taking money out of your pension and putting it back in to benefit from tax relief multiple times.
Under these recycling rules, HMRC could slap on a charge of up to 55 per cent of your lump sum if it decides you exploited this trick to generate extra tax relief.
Morrissey says that if you want to reinvest tax-free cash back into a pension, you should speak to a financial adviser.
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