Tax-free cash changes off the table – but what if it’s too late?

The government has confirmed it has no plans to change the tax-free lump sum allowance in its upcoming Autumn Budget.

The Treasury told the Telegraph it would not make cuts to the allowance.

That will induce a huge sigh of relief for many Brits – but for thousands, they have already reacted to the speculation and it’s too little too late. And taking your tax-free cash out is likely to do more harm than good unless you’re planning to spend it on something in the near future.

Once you take this money out of your pension, it stops growing in a tax-free environment, and you have significantly dented your pension pot, meaning lower compound growth in future.

So what if you’ve already taken your tax-free lump sum out?

First of all – don’t panic, because there are options.

For one, you might be able to put some money back into your pension so it can keep growing tax-free. But the tax implications of future contributions or withdrawals will change. 

If you have taken out any more than your 25% tax-free lump sum, you will only be able to put £10,000 back into your pension per year (down from £60,000) while benefitting from pensions tax relief.

That’s because of the ‘Money Purchase Annual Allowance’, which caps future contributions for anyone who is drawing on their pension to £10k.

If you have only taken your tax-free cash, you may be able to put more than this back in, but beware of falling foul of HMRC’s pension recycling rules (where you take cash out your pension then put it back to generate double tax relief). You’d need to be able to demonstrate you weren’t trying to ‘double dip’ on pensions tax relief, which may be hard to prove.

Also, be aware that putting the cash back will not mean that you can take it back out again tax-free. Any future withdrawals will be taxed at your marginal rate of income tax.

Because of that, it may be a good idea to focus on spending your tax-free cash before taking any more money out of your pension. In the meantime, put as much of the cash as possible into an ISA so that the returns or interest are tax-free.

For the remaining savings, make sure you’re getting the best interest rate possible or, if you don’t need the money imminently, consider investing it. The stock market has historically outperformed money held in cash long-term.

For those approaching retirement, consider lower-risk investments. Some stocks and shares ISAs or investment platforms will have lower-risk portfolios tailored for people nearing retirement.