Are YOU tempted to cash in a large pension? Many unwary savers could be whacked with income tax bills

People who cash in large pension pots could be unwittingly landing themselves with hefty tax bills, new research reveals.Making withdrawals over and above your 25 per cent tax-free lump sum can push you into a higher tax bracket, and limit how much you can benefit from pension tax relief in future.Analysis of official data about people who took an entire pension fund worth £100,000-plus shows they stumped up a collective £87.2million in tax between October 2024 and March 2025.That amount was 20 per cent higher than the year before, and some people would have been hit with five-figure tax bills after accessing pensions in one go, according to the study by Standard Life.It says large pension withdrawals can lead to unexpectedly high tax bills, and many retirees might have paid far more than they might have anticipated.Although we don't know the reasons why people cashed in big pension funds, Standard Life suspects upcoming changes to inheritance tax to start including pensions could be influencing people's decisions. Income trap: Large pension withdrawals can lead to unexpectedly high tax billsThe Government announced in the autumn 2024 Budget that pensions would become liable for IHT, like other assets such as Isas and property, starting in spring 2027. Some 392 people paid at least £98,700 in tax each after cashing in pots over £250,000, the firm found after crunching Financial Conduct Authority figures.And 1,772 people who fully cashed in pots worth £100,000 to £249,000 would have paid at least £27,400 each.Standard Life didn't include tax paid on full withdrawals from smaller pots or regular withdrawals.It notes that the final tax bill for those who choose to cash in their pension in one go depends on someone’s wider income, so many people could have paid more than the figures above suggest. Standard Life says the pending inheritance tax changes could mean some savers consider withdrawing funds earlier, even if that means paying income tax, rather than leaving them exposed to IHT later.Many families are currently casting about for ways to avoid the new levy on pensions, including spending or gifting the money.Read our guides to avoiding inheritance tax legally, and on protecting your pensions from inheritance tax.Some people also use pensions to pay off debts including mortgages or make big-ticket purchases, but you need to do the sums to make sure you don't end up with an unnecessary tax bill.How much can pension withdrawals cost in tax?Any withdrawal above the 25 per cent tax-free lump sum is usually treated as income, so you can quickly be pushed into higher and additional rate tax bands. Income above £125,140 is taxed at 45 per cent.Income tax rates and bands are here, but they are different in Scotland so go here.Someone fully withdrawing a pot worth £174,500, midway between £100,000 and £249,000, might face a tax bill of around £64,700 before factoring in any additional income, says Standard Life.If you cashed in a £500,000 pension in one go you could face a tax bill of more than £150,000, while withdrawals of £1million cost you £300,000.Meanwhile, there are other pension tax traps to be aware of such as the limit known as the 'money purchase annual allowance'.When you start tapping a defined contribution pension pot for any amount over and above your 25 per cent tax free lump sum, you are only able to put away £10,000 a year and still automatically qualify for valuable tax relief from then onward.There is also an emergency tax trap, which HMRC ended for people making regular withdrawals from April 2025. Mike Ambery: Decisions about pensions can be difficult to reverse, so check the implications before making a withdrawal.However, some people making one-off withdrawals still end up having to claw back overpaid tax from HMRC. Read our guide on how to defend your pension from the taxman.Mike Ambery, retirement savings director at Standard Life says: 'Life doesn’t always follow a set path, and when people reach the point of accessing their pension, there are often a lot of competing priorities.'For some, taking a larger amount upfront will feel like the simplest option, but it can come with a sting in its tail in the form of a higher tax bill than many expect.'What catches people out is how quickly a single withdrawal can push them into higher tax bands. Taking a bit of time to understand how withdrawals are taxed, and spreading them more carefully, can make a real difference over time.'Ambery adds: 'As inheritance tax changes loom, for some this prospect may lead to decisions about accessing their savings earlier than they otherwise would have.'However, it’s important to weigh it up carefully - taking money out sooner can mean bringing forward income tax liabilities, and in some cases paying more than expected.'Fully withdrawing means you may also lose out on potential investment returns, depending on what you do with it next.'How to avoid a big pension tax billMike Ambery of Standard Life offers the following tips.1. Watch the £50,000 and £125,000 thresholdsIncome above £50,270 moves into higher rate tax, and above £125,140 into additional rate, although the banding works differently in Scotland, he says.What we often see is that a single withdrawal can push people across both thresholds in one go, which significantly increases the amount of tax they pay.Spreading withdrawals across tax years is one of the simplest ways to manage this more effectively.2. Factor in your state pensionA full state pension of £12,548 uses up over 99 per cent of the personal allowance of £12,570, which means there may be very little tax-free headroom left for other income.As a result, additional withdrawals from a private pension could be taxed from the first pound.3. Don’t take it all at onceWithdrawing your entire pension pot in one go is often the most expensive option from a tax perspective.While it can be tempting to take control of the money straight away, doing so can push much of it into higher-rate tax.In many cases, taking withdrawals gradually over time can reduce the total tax paid. This approach can also provide more flexibility as circumstances change.4. Use your tax-free cash carefullyUp to 25 per cent of your pension can usually be taken tax-free, but that doesn’t mean it all needs to be taken upfront.Phasing tax-free cash alongside taxable withdrawals can help smooth out your overall tax position. This can be particularly helpful for managing income across different years. (Read more about the benefits of taking your tax-free lump sum in chunks.)5. Pause and check before you actDecisions about pensions can be difficult to reverse, so it’s worth taking a moment to check the implications before making a withdrawal.Fully withdrawing may also restrict your ability to save into your pension in the future due to the money purchase annual allowance which reduces your allowance if you start taking taxable income from your pension.6. Consider guidance or advice before making decisionsPension decisions can have significant long-term implications, and taking all your pension at once could leave you financially vulnerable, especially if you rely solely on the state pension.See below on getting financial advice, or use the Government's Pension Wise service which offers free appointments.SIPPS: INVEST TO BUILD YOUR PENSIONAJ BellAJ Bell0.25% account fee. Full range of investmentsHargreaves LansdownHargreaves LansdownFree fund dealing, 40% off account feesInteractive InvestorInteractive InvestorFrom £5.99 per month, £100 of free tradesInvestEngineInvestEngineFee-free ETF investing, £100 welcome bonusProsperProsperNo account fee and 30 ETF fees refundedAffiliate links: If you take out a product This is Money may earn a commission. These deals are chosen by our editorial team, as we think they are worth highlighting. This does not affect our editorial independence.Compare the best Sipp for you: Our full reviews