More than 221 people are thought to have fully withdrawn a pension pot of £250,000 or more between October 2022 and March 2023

Many retirees over 55 are being stung by hefty tax demands after cashing in substantial chunks of their pension savings, often due to confusion about the rules. Standard Life’s analysis discovered that more than 221 individuals fully withdrew pension pots worth £250,000 or up between October 2022 and March 2023, resulting in tax bills of at least £97,500.

Taking your pension in a large lump sum might appear to be an attractive option for kick-starting your retirement, but it could leave you with an eye-watering tax liability. Mike Ambery, who is the retirement savings director at Standard Life, has cautioned those considering similar actions, stating: “There can be a big cost to not considering tax when you access your pension.”

He elaborated on the importance of this issue by adding: “Many people understandably don’t think about how much tax they’ll need to pay from their pension income. However, it’s important to bear in mind, especially when it comes to the critical moment of accessing pension savings.“

Standard Life’s research highlights concern among the over-55s, with a third (33%) lacking confidence in their grasp of how pension withdrawals are taxed, while only 29 per cent feel sure about their options.

How can I access my pension pot?

When discussing how individuals can access their pension pot, Mr Ambery outlined several paths, including taking some or all of the pot as a cash lump sum, but he cautioned: “Beware of that. Tax charges might apply to reduce the money you receive significantly.”

Alternatively, you could opt for an annuity, reports the Express. Mr Ambery explained: “It’s an annual income that will be paid to you for the rest of your life. There are many types of annuities available to buy – you should shop around to find the best one that suits you.”

He also mentioned: “It’s possible to use part of your pension to buy an annuity, securing a level of income, and leave the rest to access flexibly.”

Individuals can also take money directly from their pension fund while keeping the remainder invested through income drawdown.

Or, they might select a combination of these methods.

What are the tax implications of each option?

When it comes to tax implications for each choice, Mr Ambery clarified that retirees can withdraw their entire pension pot in cash, no matter the size. He pointed out that 25 per cent of the total amount would be tax-free, with the rest being taxed as income.

He added: “You can also take smaller sums as cash whenever you need to, and 25 per cent of each sum will be tax-free. Any taxable money you take from your pension will be added to your other income for that year and taxed at the relevant income tax band. It’s important to be aware that this may take you into a higher tax bracket than normal.”

The tax you pay on your pension income depends on your tax band if you choose a flexible income or annuity. For instance, in England, income from pensions above the tax-free amount, between £12,570 and £50,271, is typically taxed at 20 per cent.

With a flexible income, you can set up a regular income and adjust it as needed, including making one-off withdrawals. Mr Ambery noted that an annuity provides a regular income that only changes if you’ve chosen options like inflation protection.

Do I pay tax on my state pension?

Your state pension is taxable, but the tax isn’t deducted directly. Instead, tax is usually taken from other income sources that, when combined with your state pension, push your total income above the personal allowance.

Mr Ambery said: “The full new state pension is just over £11,500 in the current tax year, which is less than the standard personal allowance of £12,570. So, this won’t be taxed, but it does count as part of your total annual income.”

From April 1, 2025, the state pension will increase by 4.1 per cent to £11,975 per year, moving closer to the personal allowance threshold. Mr Ambery recommended using resources like the Government’s free Pension Wise guidance service or consulting with pension providers for more detailed advice, as “withdrawals are a complex area”.