How much tax-free cash can I take from my pension?

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.

Taking a tax-free lump sum and buying an annuity doesn’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. Learn more about annuities in our guide Annuities explained.

If you prefer more flexibility, then you may decide 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 a different provider.

Over the long term, this should 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 the risks involved.

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. Under current rules, they won’t typically need to pay Inheritance Tax (IHT) on drawdown money, as these savings are considered to be outside of your estate, but as mentioned, this is due to change in 2027, when pensions will fall into the scope of Inheritance Tax for the first time. Learn more in our guide What happens to my pension when I die?