A costly retirement mistake: why how you take your pension matters

Your pension savings are there to support you throughout retirement. But the way you take money from your pension can have a big impact on how much you keep.

Taking withdrawals without a plan could mean paying far more tax than necessary. In some cases, people withdraw large amounts in one go and accidentally push themselves into a higher tax band. That can mean paying thousands of pounds more in tax than they expected.

Understanding your options before you take money from your pension can help your savings last longer and work harder for you.

When you can take money from your pension

For most people, you can start taking money from a private or workplace pension from age 55. This will increase to age 57 from April 2028 under current rules.

Although you may be able to access your pension at that age, it does not mean you need to take it all at once. Pensions are designed to provide an income throughout retirement, which for many people could last 20 or 30 years or more.

Your main options at retirement

When you decide to start using your pension savings, there are a few different ways you can take the money.

Many people choose to take up to 25% of their pension as a tax-free lump sum. This is normally available when you first access your pension, although there is a lifetime limit set by the government on how much can be taken tax-free. Tax treatment depends on your individual circumstances and may be subject to change in the future.

Another option is to keep your pension invested and withdraw money gradually when you need it. This approach, often called drawdown, allows the rest of your pension to remain invested so it still has the potential to grow, however, investments can also fall in value, and returns are not guaranteed.

Some people prefer more certainty and use their pension to buy an annuity, which provides a guaranteed income for life.

In reality, many retirees use a combination of these approaches depending on their needs and circumstances.

Why large withdrawals can mean higher tax

One of the most common pension mistakes is withdrawing too much money in a single tax year.

While the first 25% of most pensions can usually be taken tax-free, depending on your circumstances, the remaining 75% is treated as taxable income. This means it is added to any other income you receive that year, such as earnings or the State Pension.

If you withdraw a large amount in one go, it could push part of your income into a higher tax band. In some situations, people have paid significantly more tax than necessary simply because they did not spread their withdrawals across several tax years.

Taking smaller, planned withdrawals may help you manage your tax position more efficiently.

Making your pension last

Retirement income planning is not only about tax. It is also about making sure your pension lasts as long as you need it to.

If you withdraw large sums early in retirement, your pension may have less time to benefit from potential investment growth. This could reduce the income available to you later in life.

Balancing what you need today with what you might need in the future is an important part of retirement planning.

Getting guidance before making decisions

Because pension choices can be complex, it is often helpful to get guidance before making decisions.

MoneyHelper offers a free government-backed service called Pension Wise, which explains the options available when accessing your pension. A financial adviser can also help you create a retirement income plan based on your personal circumstances.

The key takeaway

Accessing your pension is one of the most important financial decisions you will make in retirement. While the rules give you flexibility, the choices you make can affect how much tax you pay and how long your savings last.

Taking time to understand your options and plan your withdrawals carefully could help you keep more of your pension working for you throughout retirement.

This article is for information only and does not constitute financial advice. Tax treatment depends on individual circumstances and may change in the future.

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