What Happens If I Take 25% Of My Pension At 55? The Complete Guide

When you turn 55, you have more options for your pension. One of the most popular is to take 25% of your pension pot as a tax-free lump sum. You can choose this option when you turn 55 (it will go up to 57 in 2028), but what happens when you do it? Is it a good idea for your financial future?

I’ve helped many clients navigate this decision, and it’s rarely straightforward. Let’s break down everything you need to know about taking that tax-free 25% and what happens to the rest of your pension.

The Basics: Tax-Free Cash at 55

You can get to your private pension plan and most workplace pension plans if you are at least 55 years old. The first 25% of your pension pot can be taken out tax-free. This has become a very popular choice for many people getting close to retirement age.

But what actually happens after you take this money? Well that depends on what type of pension scheme you have and what you choose to do with the remaining 75%.

What Happens to the Rest of Your Pension?

For Defined Contribution Pensions

If you have a defined contribution pension (like a Self-Invested Personal Pension or workplace pension):

• The remaining 75% stays invested – Your money continues to have the potential to grow in the stock market
• You can still access it – But any further withdrawals will be subject to income tax at your marginal rate
• You have flexibility – You can choose when and how to access the remaining funds

Taking that initial 25% doesn’t lock you into any particular path for the rest. You still have multiple options for the remaining 75%.

For Defined Benefit Pensions

If you have a defined benefit scheme (also known as a “final salary” pension)

• The scheme works differently – your benefits are based on salary and length of service
• When you take your tax-free cash, the guarantee of income remains in place
• However, in some cases, withdrawing your tax-free cash may reduce the income you’ll receive at retirement

Your Options After Taking the 25%

Once you’ve taken your tax-free lump sum, you have several options for the remainder:

1. Leave it invested – Keep the remaining 75% invested and access it gradually over time
2. Buy an annuity – Use some or all of the remaining funds to purchase a guaranteed income for life
3. Take additional lump sums – Withdraw more money as needed, but these will be taxable
4. Full withdrawal – Take the entire remaining amount (subject to income tax)

Option 1: Leave it Invested (Pension Drawdown)

This is the most flexible option. Your pension remains invested, and you can:

• Take income as and when you need it
• Adjust your withdrawals to manage your tax position
• Leave your pension to grow further if you don’t need the income immediately
• Pass on any remaining pension to your beneficiaries when you die

The drawback? Your pension isn’t guaranteed to last forever. Poor investment performance or withdrawing too much too soon could deplete your fund.

Option 2: Buy an Annuity

An annuity provides certainty. You sell your pension fund to an insurance company who promises to pay you a guaranteed income for the rest of your life. This means:

• You know exactly how much income you’ll receive
• The payments continue regardless of how long you live
• You don’t have to worry about investment decisions
• There’s no risk of running out of money

The downside? Annuity rates might not be particularly attractive, and once purchased, you generally can’t change your mind or access the capital.

Option 3: Take Additional Lump Sums

You can continue to take lump sums from your pension. Each withdrawal is partially tax-free (25% of the time) and partially taxed (75% of the time).

This approach can be useful if you need larger amounts occasionally rather than a regular income.

Option 4: Full Withdrawal

You could withdraw the entire remaining amount, but this is rarely the best option because:

• The entire amount (after the initial 25% tax-free portion) would be added to your income for that tax year
• This could push you into a higher tax bracket
• You’d lose the tax advantages of keeping money within a pension
• You’d need to find alternative ways to provide income throughout retirement

Tax Implications of Taking Your 25%

The tax situation is pretty straightforward:

• The initial 25% lump sum is completely tax-free
• Any further withdrawals from the remaining 75% are taxed as income
• This means they’re added to any other income you have in that tax year
• Withdrawing large amounts could push you into a higher tax bracket

Watch Out for the Money Purchase Annual Allowance

Taking your tax-free cash generally won’t affect your ability to continue paying into a pension. However, once you start taking taxable income from your pension (from the remaining 75%), the amount you can contribute to pensions each year and still receive tax relief may be reduced.

Currently, the Money Purchase Annual Allowance is £10,000 per year (as of 2023). This means if you want to continue building your pension pot significantly, taking taxable income could limit your options.

Should You Take Your 25% Tax-Free Lump Sum at 55?

This is a personal decision that depends on your individual circumstances. Here are some factors to consider:

Potential Benefits

• Access to cash – You get a potentially significant lump sum to use however you wish
• Tax efficiency – The 25% is completely tax-free, regardless of your other income
• Flexibility – You can use the money for major expenses like paying off your mortgage or funding home improvements
• Timing control – You can choose when to take it based on your needs

Potential Drawbacks

• Reduced retirement income – Taking 25% now means less in your pension to generate income later
• Investment risk – If you invest the money elsewhere, you may face investment risks
• Tax implications – Poor planning with the remaining 75% could lead to unnecessary tax bills
• Temptation to spend – Having a large sum available might lead to spending that doesn’t support long-term financial goals

Real-Life Considerations

When making this decision, think about:

1. Your financial goals – What do you want to achieve in retirement?
2. Your other sources of income – Do you have other pensions, investments, or income streams?
3. Your health – How long might you need your pension to last?
4. Your tax position – How will withdrawals affect your overall tax situation?
5. Your risk tolerance – How comfortable are you with investment risk?

Can I Continue Working After Taking My Pension?

Yes, you can keep working after you start getting your pension at age 55. When you start getting your pension, you don’t have to quit your job or cut back on your hours.

This means you could:

• Take the 25% tax-free cash while continuing in your current job
• Use the lump sum for a specific purpose while your salary covers day-to-day expenses
• Gradually reduce your working hours while supplementing your income from your pension

Common Questions About Taking 25% at 55

Can I take 25% of my pension tax-free at 55?

Yes, when you reach 55 (rising to 57 from 2028), you can normally take up to 25% of your defined contribution pension completely tax-free.

What happens to my pension if I take 25%?

The remaining 75% stays invested in your pension pot. You can either leave it there to potentially grow, use it to provide an income through drawdown, or use it to buy an annuity.

Can I take my pension at 55 and still work?

Absolutely! There are no restrictions on continuing to work after you’ve started taking benefits from your pension.

How do I take 25% of my pension at 55?

You’ll need to contact your pension provider and request to take your tax-free cash. They’ll have a process for you to follow, which typically involves completing some forms and making decisions about what you want to do with the remaining 75%.

Is it better to take a lump sum or monthly pension?

This depends entirely on your personal circumstances. A lump sum gives you control and flexibility, while a monthly pension (like an annuity) provides security and certainty.

Final Thoughts: Proceed with Caution

Taking 25% of your pension at 55 can seem like an attractive option, and for many people, it’s a valuable financial move. However, it’s not right for everyone.

Remember that your pension is designed to provide income throughout your retirement, which could last 30+ years. Taking money out early reduces what’s available later.

Before making any decisions, I strongly recommend speaking with a financial advisor who specializes in retirement planning. They can help you understand all your options and make the choice that best supports your long-term financial wellbeing.

The decision you make about your pension at 55 will have significant implications for your financial future. Take the time to fully understand your options, consider the pros and cons, and get professional advice if you need it.

Your future self will thank you for making a well-informed decision!