A £10,000 pension withdrawal could leave savers hundreds of pounds worse off if taken the wrong way. Martin Lewis says many people are falling into what he calls a “massive tax trap” when accessing their retirement funds.
The financial campaigner used a simple example on his ITV programme, later shared by Money Saving Expert, to show how the method of withdrawal, not just the amount, determines how much tax is paid. According to the site, choosing the wrong option could mean handing £150 or £300 more to the Treasury than necessary, with the difference rising proportionally for larger sums.
Currently, people can access private pensions from age 55, rising to 57 in April 2028. While early withdrawals are permitted, they can reduce future retirement income and may also limit how much can be paid back in later.
How Pension Withdrawals Are Taxed
Under existing rules, 25% of a pension pot can be taken tax-free. The remaining 75% is taxed at the individual’s marginal income tax rate. As Martin Lewis explained on his programme, if someone withdraws £10,000 directly from their pension, £2,500 is tax-free and £7,500 is taxed at their current rate.
For a basic rate taxpayer, that portion is taxed at 20%. For a higher rate taxpayer, it is taxed at 40%. According to Money Saving Expert, the issue arises when individuals withdraw funds during years in which they are paying tax at a higher rate than they expect to pay in retirement.
Lewis illustrated the point with what he described as a “Swiss roll” analogy. Each slice of pension taken under a standard withdrawal keeps the 25% tax-free and 75% taxable proportions intact. That means savers cannot simply extract the tax-free element alone if they withdraw funds in this way.
The tax implications can also affect someone’s wider income position. According to guidance cited from Citizens Advice, any taxable pension withdrawal is added to other income received during that tax year. This can push individuals into a higher tax band than usual, increasing the overall bill.
Alternative Options and Why Timing Matters
Lewis highlighted an alternative approach: taking the 25% tax-free lump sum separately and placing the remaining 75% into an income drawdown arrangement or purchasing an annuity. Under this structure, savers can withdraw the tax-free portion first and defer accessing the taxable balance.
According to Money Saving Expert, this can be particularly beneficial for those who expect their income to fall in retirement. Someone currently paying 40% income tax who later becomes a basic rate taxpayer could face a significantly lower bill by delaying withdrawals from the taxable portion.
For example, withdrawing £10,000 while paying the higher rate means £7,500 is taxed at 40%. If that same £7,500 were accessed later at 20%, the difference in tax paid would be substantial. Lewis told viewers that over time, and with larger sums, the gap could amount to “thousands or tens of thousands of pounds”.
Citizens Advice also notes that savers may take their entire pension pot as cash if they choose, or withdraw smaller amounts over time. In every case, 25% of each withdrawal remains tax-free, with the remainder treated as income. The organization stresses that professional guidance should be sought before making decisions about personal or workplace pensions.
