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Written by Retirement Line
Page last reviewed: 6th December 2024︱Next review date: 6th December 2025
You can take a tax-free cash lump sum to spend as you wish
Whilst your pension fund exists to provide an income for your retirement, you have the option to access it however you wish from the age 55 (rising to 57 from April 2028). Normally, up to 25% of your overall pension fund can be taken entirely tax free; benefits from the rest are classed as taxable income.
This is our guide to how the tax rules work for lump sums and the main options available to access your pension tax-free lump sum.
If you are considering an annuity then do speak to our Annuity Specialists to fully understand your options for accessing your lump sum allowance. You may also wish to take advice from a financial adviser or tax specialist.
There are two main types of pension schemes, each with their own rules as to how you can access your money. These are defined contribution and defined benefit pension schemes.
Defined contribution Schemes
A defined contribution (DC) scheme is also known as a money purchase pension. Some workplace pensions and personal pensions such as self-invested personal pensions (SIPPs) come under this umbrella.
With these, you can usually take up to 25% of your total pension pot as tax-free cash once you reach 55 years old known as the ‘normal minimum pension age’. This is rising for most people to age 57 from 6 April 2028, affecting those born after 6 April 1971. Some people will be able to access their fund earlier in certain circumstances, including those with qualifying ill health or a protected pension age.
You can access more money if you wish, though anything over your 25% tax-free allowance will be taxable.
So, for example:
If your pension fund is worth £80,000 and you choose to access £20,000 (25%), this will be tax-free.
If you choose to take £40,000 from your fund (50%), perhaps to clear your mortgage, then the first £20,000 would be tax-free. You would have to pay tax on the additional £20,000 – the amount over your 25% allowance.
Defined benefit schemes
If you have a defined benefit (DB) pension – also known as a final salary – then the rules may be a little different for you.
A DB pension scheme pays you based on how many years you’ve been a member of the employer’s scheme and how much your salary is when you leave or retire.
How much tax-free allowance you have and how you can access your money will be determined by your own defined benefit scheme’s rules. You may find that you can access more than 25% of your pension tax-free.
Remember – whichever scheme you have – the money you withdraw from your pension fund will reduce the amount you have left for your retirement. With a defined contribution scheme, if you have no real need for the money now, leaving it untouched in your fund could allow it to grow further until you decide to use it.
The maximum pension tax-free lump sum you can take is typically 25% of the total pot. However, there are some allowances that could restrict how much you can take tax-free from larger pension pots. Additionally, some older pension schemes allow for more than 25% to be taken as a tax-free amount, so it is important to check the terms with your pension provider.
Below are the main rules regarding the pension tax-free lump sum.
Lump Sum Allowance (LSA). If you withdraw more than the LSA of £268,275 as a lump sum, the excess will be taxed at your marginal rate of income tax.
Lump Sum Death Benefit Allowance (LSDBA). This limits all your tax-free lump sums to £1,073,100. If a lump sum exceeds the LSDBA, it will incur an income tax charge. This allowance is higher than the LSA as it covers both lump sums taken while you are alive, and any lump sums passed to your beneficiaries should you die before age 75. If you die on or after your 75th birthday, the LSDBA does not apply because 100% of any pension income or lump sum passed to a beneficiary from that date is taxable at their marginal rate of income tax.
Lifetime Allowance (LTA). This was an allowance that limited the maximum size you could allow your pension pots to grow to without facing an additional tax charge. This limit was £1,073,100.
Could you be entitled to a higher tax-free lump sum? It is important to note that if you have Lifetime Allowance protection in place, you may still benefit from higher tax-free lump sums, so your LSA and LSDBA allowances may be higher than the standard levels.
You can check your existing LTA protection status by signing in to your personal account on the Government Gateway portal. If you have not previously applied for allowance protections then you can still apply for Fixed Protection 2016 and Individual Protection 2016. However, the application deadline for both of these is 5 April 2025.
Important: The above is for information purposes only – Retirement line are not tax specialists so if you think that these allowances or protections affect you, please talk to your pension scheme provider or a financial adviser specialising in taxation and/or pensions for assistance.
You can currently access your defined contribution pension fund from age 55, though this is changing to 57 from 2028. Whether you should or not depends on your individual circumstances and your financial goals for retirement.
Despite being able to access your pension pot from this age, you may choose to delay taking your pension’s tax-free lump sum – or not take a lump sum at all. This would allow the money to stay in your pension scheme with the opportunity to grow until you need it.
Taking your tax-free allowance too early could mean you don’t have enough money left to meet your retirement income needs in the future. You will need to think about this carefully before making a decision.
On the other hand, you may wish to take your tax-free cash as early as age 55, depending on your situation. For instance, if you have several pension pots, you might decide to withdraw 25% from one of them to meet a pressing financial need.
For example, this cash could clear outstanding debts, such as a mortgage. This could ease your financial burdens, save on interest costs and potentially allow you to move towards retirement with fewer financial obligations.
Once you access your tax-free cash, you’re free to spend or save it as you wish. However, it’s wise to remember that inflation gradually reduces the purchasing power of money. With this in mind, you might consider withdrawing only what you need for now, especially if you don’t have a specific use for the entire amount you could access.
By leaving the remaining balance in your pension, it can continue to grow tax-free, potentially resulting in a larger tax-free sum in the future.
You can take your pension tax-free cash as a lump sum, or in stages.
If you choose to take your tax-free money from your pension fund then you have four main options:
Arrange an annuity for regular guaranteed income: Access the tax free cash available from your pension pot before you purchase your annuity with the remaining money. You may be able to take a bigger lump sum, but anything over 25% will usually be taxable. Also, with a fixed-term annuity, some providers let you take taxable lump sums during the term, in addition to agreed regular payments.
Arrange a pension drawdown scheme: Access your available tax-free cash and the rest of the money is invested. This gives your money the opportunity to continue growing, though there are risks to consider with drawdown.
Take your money in smaller amounts: 25% of each amount you withdraw could be taken tax free. The remaining 75% of each amount will be taxable if you exceed your personal allowance.
Take your full pension fund in one go: If you do this, 25% of your pension fund will be paid to you tax-free. The remaining 75% will be taxable if you exceed your personal allowance for the tax year.
Here at Retirement Line we specialise in annuities that provide you with a guaranteed income in retirement. Speak to our friendly annuity specialists on 01733 973038 today to compare annuity types and get the best deal possible for you.
If you saved up your pension fund with multiple pension schemes over your career then you can take a tax-free lump sum from each of them if you wish. You can normally do this in two main ways:
Access up to 25% of each fund tax-free.
Consolidate your various pension pots into one large fund before accessing up to 25% of it as a tax-free lump sum. This may make your pension savings easier for you to manage in the future. Because of benefits that could be lost on transfer you should consider seeking professional independent financial advice prior to consolidation
The good news is that any tax-free lump sum you take from your pension fund will not affect your personal allowance. After taking the tax-free money from your pension fund, you will still be able to enjoy the full personal allowance for that tax year entirely tax-free. For 2024/25 the personal allowance is £12,570.
After accessing the 25% tax-free portion of your pension fund, you will pay income tax on the benefits from the remaining 75% of your pension fund.
No, you do not have to declare your 25% pension tax-free lump sum as income in your tax returns. The remaining 75% of your pension fund does however count as income when you access it.
Your entitlement to some means-tested state benefits may be affected by a pension tax-free lump sum. This is because the money you receive can count when any means tests are carried out to check your eligibility.
For example, means-tested state benefits such as Universal Credit or Pension Credit are given to people on the lowest incomes, with little or no savings set aside. If you receive a large cash lump sum from your pension fund then your entitlement could be impacted.
For this reason it’s very important to check if your entitlement to some state benefits could be affected by your pension tax-free lump sum before deciding anything.
Where can I keep my pension tax-free lump sum?
It is up to you where you put your pension tax-free lump sum. If you move it into your savings account or a cash ISA then do bear in mind that inflation could erode its value.
You should also consider that the Financial Services Compensation scheme limit to protect cash deposits is currently £85,000 (or £170,000 for joint accounts) per firm.
Ultimately, how you access your tax-free money is your decision. Some people opt for the maximum tax-free cash, some want the maximum annuity income, others want a combination of the two. What is right for you depends on your personal circumstances and needs. It may depend on other sources of income you have, such as from employment, the State Pension and other private/personal pensions.
We hope you found this guide helpful in explaining how the tax rules work for pension commencement lump sums. If you want to talk to someone about annuities, annuity rates or how much tax free lump sum cash from your pension is possible, call us today. Our Annuity Specialists can provide information on your options for taking your lump sum allowance.
You can speak to our friendly team today by calling 01733 973038 or request a free call back here.
You may wish to keep inheritance goals in mind when deciding how much tax free lump sum to take from a pension.
For now, pension funds are typically exempt from inheritance tax. This means that your funds can be passed on to your beneficiaries without the fund value being counted as part of your estate. Taking pension tax-free lump sums out of your pension savings and into your taxable estate could therefore reduce the amount of tax-free inheritance you leave.
However, in the Autumn Budget of October 2024, the Chancellor announced that inherited pensions will be subject to Inheritance Tax (IHT) from 6 April 2027. This will be within existing IHT rules: IHT is not payable by a person’s spouse or civil partner, and is only typically payable on estates over relevant IHT thresholds.
Current rules also state that if you pass away before age 75, your heirs can inherit your pension funds or annuity income without paying income tax on it. Retirement Line’s understanding is that beneficiaries may still be liable for income tax on inherited pension income from April 2027, although it isn’t clear whether the ‘age 75’ rule will remain.
More information will be available following a government consultation period that will run until early 2025. We are monitoring this issue and will report on it once the matter is clarified. Please see our Budget report for more information: Budget 2024 – pensions brought into inheritance tax from 2027.
You might find that it is worth holding off on accessing your pension tax-free lump sum under certain circumstances. For instance, if you have no immediate financial need for a lump sum or pension income you may wish to leave your pension savings invested.
Many people underestimate how long they will live for. If you plan to use your pension to provide a regular income, delaying taking your lump sum and income could reduce the risk of running out of money during your retirement.
It's also worth considering that taking money from your pension early might limit your future contributions due to the Money Purchase Annual Allowance (MPAA). This restricts how much you can add to your pension tax-efficiently once withdrawals have begun.
Most individuals can contribute up to £60,000 to their pensions each tax year and still benefit from tax relief, including any contributions made by their employer. However, triggering the MPAA by taking your tax-free lump sum reduces this annual limit to £10,000. The MPAA applies only to contributions made to defined contribution pensions and does not affect defined benefit pension schemes.
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Retirement Line Limited is Authorised and Regulated by the Financial Conduct Authority, FCA No. 726601. Retirement Line Limited is registered in England and Wales, registration No. 6976976. Registered Office: 52 Forder Way, Hampton, Peterborough, PE7 8JB
*Equifax Touchstone pension income and annuity sales figures 2018 to 2020. Matrix Financial Solutions Inc annuity sales figures 2021 to 2023.
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