While switching to ISAs, do-it-yourself pension investors take tax-free cash

In anticipation of a pension tax raid in the Autumn Budget, investors in self-invested personal pensions (SIPPs) are scrambling to take their tax-free money and are resorting to ISAs

Data from one of the UK's biggest investment platforms shows that a surge in withdrawals from self-invested personal pension (SIPP) savers is being driven by fears of additional pension reforms in chancellor Rachel Reeves' Autumn Budget.

According to Bestinvest, its do-it-yourself pension savers received 33% more demands for their money in September than they did on average over the preceding two years.

The investment platform stated that this was mostly due to people over 55 accessing their 25% tax-free cash lump sum.

As retirees cashed out, the amount of pension income withdrawals from SIPPs, also known as a pot for life pension, increased by 146% in September when compared to the two-year average for the same month in 2023 and 2024.

"Saving into a pension is a long-term financial goal that requires commitment from a saver but also a stable and consistent approach from the government," stated Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners.

"Continued speculation about pension changes can have serious consequences because it may deter savers from increasing their retirement funds at a time when they are already facing criticism for their inadequate contributions.

Why are ISAs becoming more popular among investors?

It appears that fewer people are using traditional retirement products to save for their golden years as a result of uncertainty surrounding pension taxes. According to Bestinvest, SIPP contributions increased by just 3% last month.

On the online investment platform, ISA contributions increased by 38% in September when compared to the two-year average for the same month. Unused defined contribution pensions will be subject to inheritance tax starting in April 2027, a move that is believed to reflect savers reevaluating their retirement saving practices.

ISAs can be spent whenever you want, but they are also subject to inheritance tax, unlike pensions.

In contrast to the previous two-year average for the same period, Bestinvest's SIPP contributions decreased by 24% over the three months leading up to the end of September, while ISA contributions increased by 10%.

In another piece, we contrast ISAs and SIPPs.

Although they have different restrictions, Haine stated that both ISAs and pensions are useful instruments for people wishing to accumulate long-term, tax-efficient savings in the UK.

The 20,000 tax-free allowance in an ISA is not transferable to the following fiscal year, but the funds held within are not subject to taxes upon withdrawal.

A higher annual allowance (AA) and the ability to backdate contributions up to one's AA over the preceding three fiscal years are two advantages of pensions that are helpful for people who receive windfalls like inheritances or business sales.

However, like an ISA, a pension is taxable at the time of withdrawal and will also be subject to IHT in 18 months.

Reduces tax-free income.

One of the main worries is that there are rumors that the chancellor may lower the maximum amount that people over 55 who save for pensions can take out of their retirement accounts tax-free. Jeremy Hunt, the former Conservative chancellor, set a cap of 268,275, which is the maximum amount that savers can currently access tax-free, up to 25% of their pension.

Some savers later regretted their choice after realizing they did not need the money right away, but no changes were made. Similar speculation ahead of last year's Autumn Budget caused a wave of pension withdrawals.

Given that pensions minister Torsten Bell had previously supported cutting tax-free cash while leading the Resolution Foundation, a think tank, rumors of additional pension tax changes this year seem to be having a similar impact.

The rules governing gifts may change.

Many do-it-yourself investors have drastically altered their approach to pension saving since the chancellor's maiden fiscal statement last year brought pensions under the purview of inheritance tax (IHT). Instead of risking their beneficiaries receiving a hefty tax bill upon their death, they now withdraw pension funds to spend or give.

The substantial behavioral shift of more people taking larger withdrawals from their pensions prior to the Budget in order to avoid inheritance tax is also being driven by speculation about possible changes to gifting regulations, such as the possibility that the seven-year rule may be extended or that a lifetime gifting cap may be introduced.

Haine stated: "As the Autumn Budget draws nearer, we've seen a spike in tax-free cash requests at Bestinvest, which is consistent with the pattern observed prior to the chancellor's first fiscal statement last year.

As a hasty response to a potential policy change, taking tax-free cash too soon can jeopardize retirement plans and turn out to be inefficient with regard to taxes. The gain from the initial tax-free withdrawal can be offset by moving a sizable amount from a tax-protected wrapper, such as a pension, into a taxable setting, like a bank or building society savings account.

Interest, income, and capital gains may then be subject to taxation unless they are transferred into another tax-efficient vehicle, like an ISA, or fall under an existing tax-free allowance, like the personal savings allowance.

Can a tax-free cash withdrawal be reversed?

It would be prudent for anyone thinking about withdrawing sizable amounts from their pension to seek financial advice before making any decisions. According to data from the 2024 - 2025 tax year from the Financial Conduct Authority, a concerning 70% of people do not.

According to Haine, "they cannot determine whether it makes sense to access their tax-free pension lump sum now, whether it is better to leave the money invested for a longer period of time, or whether it is better to only take a portion of the 25 percent tax-free element," due to the lack of a clear picture of their retirement funding strategy.

Hastily made decisions are not always reversible. Although some providers used to let savers cancel tax-free lump sum withdrawals within a specific cooling-off period, the FCA and HMRC have recently stated that providers shouldn't let savers change their minds. This implies that once the money is taken, it cannot be reversed.