Tax free cash and drawdown

Do you know how much tax-free cash you can receive from your pension pot?

20%? 15%? 10%? No...

The answer is 25%! That's one quarter of your pension pot.

That means, if you have saved £1 million (the current lifetime allowance) you will receive £250,000 as tax-free cash when you start drawing on your pension (based on the current rules). This is a big incentive to save into your personal pension.

What happens to the rest of the pot?

Any income that is received after the initial tax-free cash is charged at your marginal tax rate. Be mindful of this, as you don't want to pay more tax than is necessary.

For example, if you are a basic rate taxpayer and take a large sum out of your pension, you could be pushed into the higher tax bracket.

What happens after you have taken income out of your pensions?

There are two things you need to be aware of:

1. Your first income payment may be emergency taxed. The first payment that is made by a pension provider is subject to the same rules as any payroll scheme. If they do not have details of your tax code (from a current year P45, or from the HMRC), you may be emergency taxed.

If you are taking monthly income, this will be balanced out over the year, but if you it is a one-off payment you can claim the extra tax back from HMRC.

2. If you want to continue contributing to your pension after you have taken income, you can only save up to £4,000 (including tax relief) per year. This is called the money purchase annual allowance (MPAA) and it is in place to stop people recycling tax-free cash.