You’ll usually be able to take 25% out of your pension as tax-free cash once you reach your pension scheme’s minimum pension age.
However, if you’re fortunate enough to have built up significant retirement savings during your working life, it’s worth noting that there is a limit on the overall amount you can withdraw tax-free.
Even if you haven’t got a big enough pension to worry about breaching the cap on tax-free withdrawals, it’s worth thinking very carefully about how much you take out of your pension, as this will affect how long your pension will last for.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
Here, we explain everything you need to know about the amount of tax-free cash you can withdraw from your pension, and the exceptions to these rules.
How much of my pension can I take tax-free?
Under current pension rules, you can usually take a maximum of 25% out of your pension tax-free once you reach the age of 55 (rising to 57 by 2028).
So, if your current pension value is £150,000, for example, you’d be able to take £37,500 out as tax-free cash. Your pension provider will take tax off the remaining amount before you get it.
However, if you have a particularly high value pension or pensions, say £1 million or above, there’s a limit on the amount of tax-free cash you can take. This is known as your Lump Sum Allowance (LSA) and in the 2024/25 tax year it stands at £268,275, which is 25% of the old £1,073 million Lifetime Allowance that was abolished at the start of the current tax year. Find out more about the Lifetime Allowance in our article What is the pension Lifetime Allowance and when was it abolished?
For example, if you have three pensions valued at £300,000, £600,000 and £400,000 respectively and wanted to take a 25% tax-free lump sum from the first pension at the age of 55, this would mean you could take £75,000 out without incurring a tax bill. Taking this amount would leave you with a maximum of £193,275 of tax-free cash that you could withdraw from your other pensions (£268,275 minus £75,000). If there wasn’t a Lump Sum Allowance in place, then you’d have been able to take total tax-free cash of £325,000 from all three pensions, but the LSA reduces this by £56,725 to the £268,275 limit.
It’s worth noting that there are some kinds of lump sum which don’t count towards your Lump Sum Allowance. For example, if you’re taking a pension that’s worth £10,000 or less in one go, or you’re taking your whole defined benefit pension and your pensions are valued at less than £30,000, or if your pension scheme is winding up and your lump sum is less than £18,000, these lump sums won’t count towards your LSA. Find out more in our article Cashing in small pensions: what you need to know.
Remember the Lump Sum and Death Benefit Allowance
As well as the Lump Sum Allowance, if you have high value pensions, there’s also the Lump Sum and Death Benefit Allowance to consider. This is the overall maximum tax-free lump sum that you and your beneficiaries (the person or people who get your pension after you die) can receive from your pension. It is currently £1,073,000 (the same as the old Lifetime Allowance). If your pension exceeds the Lump Sum and Death Benefit Allowance, then you or your beneficiaries will usually pay tax on anything above the £1,073,000 limit.
However, if you have accessed your pension prior to 6 April 2024, and you die when you are under the age of 75, the full amount of your pension should be tax-free. It won’t reduce your Lump Sum and Death Benefit Allowance, because it falls under the old Lifetime Allowance (LTA) rules. Learn more about these in our article What is the pension Lifetime Allowance and when is it being abolished?
It’s also worth noting that if you have defined contribution pensions and you die under the age of 75, your pension savings could be paid to your beneficiaries tax-free, if rather than taking a lump sum, they use drawdown to keep the money invested until they need it – or they use it to buy an annuity to provide them with an income. Learn more in our guide What happens to my pension when I die?
Can I ever take more than £268,275 in tax-free cash?
If you have a high value pension, the only way you might be able to take more than £268,275 in tax-free cash is if your life expectancy is less than a year. If this is the case, then you may be able to take all the money in your pension as a tax-free lump sum. However, all of the following must apply for you to qualify:
- you’re expected to live less than 12 months because of serious illness
- you’re aged under 75
- it’s below your Lump Sum and Death Benefit Allowance
How much tax-free lump sum to take?
Most people want to take the maximum 25% tax-free lump sum from their pension or pensions and there may be good reasons for doing this. For example:
- If you have any outstanding debts, such as a mortgage or loan: You could use your tax-free lump sum to pay off your debt (check whether there are any early repayment charges to pay).
- You may need to spend it: You may need to replace your car, do up your house or want to help your children or grandchildren financially.
- You can save tax: Few of us like to pay more tax than we have to, so taking as much tax-free cash as possible might seem like a no-brainer. Work out how much income you’d receive if you were to convert your entire pension fund into income against taking a tax-free cash lump sum. It may be that you find you’re near to a tax threshold, which means you may want to limit your (taxable) income.
However, it doesn’t automatically follow that taking the maximum tax-free cash is the best option:
- If you have a work pension: Find out how much you’d give up by taking a tax-free lump sum. For example, it may be that for every pound of income you give up you receive £12 or £15 in cash, whereas you’re actually getting more than £30 in benefit by taking income if you factor in a spouse’s pension and widow or widower’s pension.
- If you need income: It sounds silly but you might not be able to generate income that is guaranteed to last for the rest of your life more efficiently than you could if you took out an annuity with the entire fund, especially if you qualify for an impaired life annuity, which pays you a higher level of income because you have an illness or medical condition.
Pensions experts say that most of us underestimate how long we’ll live for and annuities are guaranteed to pay you an income, no matter how long you live for. Taking a tax-free lump sum and buying an annuity don’t have to be mutually exclusive as you can take out an annuity with your lump sum, known as a ‘purchased life annuity’. That said, an annuity won’t be the right option for everyone, especially as they usually die when you do, so any remaining pension savings stay with the insurer providing the annuity – as opposed to being passed to your family.
If you prefer more flexibility, then you may prefer to use drawdown – often known as flexible drawdown or flexi-access drawdown – to take an income from your pension as and when you need it. The rest of your pension stays invested, either with your current pension provider or another provider.
Over the long term, this will typically allow you to benefit from any growth in the value of your investments but it’s important to bear in mind that as your money remains invested, your pension savings could fall as well as rise in value, so you’ll need to be comfortable accepting this risk.
You’ll usually still be able to take out 25% of the funds as a tax-free lump sum at the outset. Find out more about pension drawdown in our guide to How pension drawdown works.
When you die, any money that’s left in your pension pot, can be passed on to your loved ones tax-free if you’re aged under 75 when you die (up to the value of the Lump Sum and Death Benefit Allowance ). If you die aged over 75, your beneficiaries will simply have to pay income tax on any income taken from it. They won’t typically need to pay Inheritance Tax (IHT) on drawdown money, as these savings are considered to be outside of your estate. Learn more in our guide What happens to my pension when I die?
Options for your tax-free cash
Unless, as mentioned above, you have a specific plan for your pension tax-free cash, such as paying off your mortgage, or helping your children or grandchildren financially, think carefully about whether you need to take your tax-free cash before you reach retirement age.
For example, there’s probably not much point taking this money out of your pension for it to just sit in a savings account, as over long-term periods cash savings are likely to lose value compared to the rising cost of living.
Bear in mind too that if you invest this money outside your pension, unless it is held in an individual savings account (ISA) you may have to pay Capital Gains Tax (CGT) on investment growth and tax on dividend income. Learn more in our guide What’s the best way to use my 25% pension tax-free cash?
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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