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This article is for general guidance only and is not financial or professional advice. Any links are for your own information, and do not constitute any form of recommendation by Saga. You should not solely rely on this information to make any decisions, and consider seeking independent professional advice. All figures and information in this article are correct at the time of publishing, but laws, entitlements, tax treatments and allowances may change in the future.
Taking a tax-free lump sum from your pension can feel like an exciting bonus after years of saving. And record numbers of people have been doing it, prompted by fears that the allowance will be cut.
But taking your lump sum isn’t always simple. Getting the timing or method wrong could mean you end up with an unexpected tax bill, or find that you don’t have enough to fund your later retirement.
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A popular perk of pensions is that from age 55 (57 from April 2028), you can usually take 25% of your pot as a tax-free lump sum.
So, if you have a pension or pensions worth £100,000, you could take up to £25,000 without paying any income tax. You can use your pension tax-free lump sum for anything you like, from clearing debts to taking a big holiday, buying a new car or making home improvements.
But you don’t necessarily have to take all the money at once. In fact, many people take their tax-free cash gradually and use it to top up their taxable retirement income. This can help reduce your overall tax bill and keep more of your pension invested for growth.
The maximum amount you can take out of all your pensions tax-free is capped at £268,275 for most people – that’s the lump sum allowance (some people may have a higher allowance if they previously applied to protect it under older pension rules).
This maximum will only affect you if all your pensions are worth more than £1,073,100 in total.
Some commentators have said they think the tax-free lump sum could be reduced in this November’s Budget.
We can’t be sure whether that will happen or not. Experts think that the lump sum allowance might be reduced, not scrapped altogether.
For example, if it’s reduced to £100,000 (which is the amount that Treasury officials considered in 2024), this change will only affect the minority of people with pots worth more than £400,000.
Experts have warned people not to take their tax-free lump sum as a knee-jerk reaction to what might happen in the Budget.
Any changes won’t necessarily happen straight away. This is the view of former pensions minister Steve Webb, now a partner at pension company LCP, who has written with colleague Tim Camfield that “Capping tax-free cash would be widely seen as ‘moving the goalposts’ for those who were approaching retirement and had made plans based on the current rules; in our view extensive transitional protections would be needed, and these would mean that extra revenue from this measure could be negligible in this parliament.”
You can access your pension tax-free lump sum from age 55 (rising to 57 from April 2028). But that doesn’t mean you have to.
Although tax-free cash can feel like a great bonus in the short-term, it’s important to think carefully about the impact of taking it from your pension – and whether your plan for it is worth the loss of income in later life.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: “Many people will use their tax-free cash for long-planned-for holidays, paying off mortgages or renovations. But you do need to have a plan for it, don’t just take it because it’s there.
“If you don’t need to take it, then it may be better to adopt a phased drawdown approach where you take your tax-free cash in chunks rather than all in one go. This gives you the opportunity for further growth as more remains invested and you can really plan how you use it most efficiently.”
Rebecca O’Connor, director of public affairs at PensionBee, agrees. “It’s important to realise from the get-go that you don’t have to do anything with it at all when you reach the minimum pension age – you can leave it where it is and continue contributing to your pension, if you wish,” she says.
“Remember that the more you access earlier on, after age 55, the less you will have in your pot to grow and keep you going later on.”
Ruth Downs, a financial planner at Truth Financial, warns that many people rush to take their lump sum without thinking it through.
“Accessing the 25% tax-free lump sum can be a powerful tool in retirement planning, but timing and purpose are everything,” she explains.
“The first thing I ask clients is whether they genuinely need the cash now, or if it’s better used in stages as part of a broader, tax-efficient income strategy. Taking it all at once can risk missed growth, or triggering higher-rate tax on other income.
“I’d encourage anyone to reach out to a professional before making a decision – too many people come to me after they’ve already taken the money, confused as to why they’ve been heavily taxed. Often, it’s because someone down the pub told them to grab it before the rules change. The key is aligning your pension withdrawals with your lifestyle goals – not just taking the cash because it’s available.”
When you’re ready to access your tax-free lump sum, you need to contact your provider. In order for the whole amount you withdraw to be tax-free, you’ll need to ‘crystallise’ your pension. Your pension becomes crystallised when you start to take an income – this usually means moving it into drawdown or buying an annuity.
You can do this in one go, or crystallise just part of your pension and take your tax-free cash in stages, which may help you manage your retirement income better in the long-term.
There are two mistakes that people sometimes make when they decide to withdraw their tax-free lump sum. The first is the tax situation. It is possible to take a lump sum out of your pension without crystallising your pot – these withdrawals are referred to as uncrystallised pension fund lump sums (UFPLS).
A drawback of this approach is that only the first 25% of each lump sum withdrawal will be paid tax-free – the remainder would be added to your income for the year and taxed at your highest rate. Another drawback of this approach is that it will restrict the level of future pension contributions you can make.
The second mistake is that thinking that you can change your mind about withdrawing your tax-free cash. You can’t cancel your request once the payment has been completed or put the money back again.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “In the run up to the last Budget people rushed to take their tax-free cash and then the change did not happen. Many thought they could simply cancel their instruction only for HMRC to confirm that they would not be able to do so – while reinvesting it back into their SIPP leaves them at risk of falling foul of pension recycling rules that could leave them with a nasty tax bill.”
It’s well worth getting financial advice, both to avoid unexpected tax consequences and so you know what it will mean for your retirement income.
You’ll be entitled to tax-free cash whether you have a defined contribution (DC) or defined benefit (DB) pension.
So far we have focused on taking tax-free cash out of defined contribution schemes, but the rules are different for defined benefit pensions (like final salary or career-average schemes, which public sector workers are more likely to have).
Unlike DC schemes which provide a pot of cash for you to manage, DB schemes pay an income based on your earnings and the length of time that you worked for that employer. This makes it harder to calculate a payment worth 25% of your pension and so they need to take a different approach.
Some schemes will pay you a tax-free lump sum in addition to your retirement income. Others will give you the opportunity to give up some of your guaranteed income, in exchange for a tax-free lump sum. Commutation is the technical term for giving up income in exchange for a lump sum – this might be what you’ll see on your pension statements if you do this.
Your scheme administrator can tell you how much tax-free cash you are entitled to, and whether you’ll need to give up any of your annual income to take it.
When accessing your pension, it’s vital to be on guard against pension scams. Fraudsters often target people in their 50s and 60s with promises of early access to their pension or help managing their tax-free cash.
If someone contacts you unexpectedly about your pension it’s almost certainly a scam. Once your money is gone, it’s very difficult to recover.
Always check that any adviser or firm is regulated by checking the Financial Conduct Authority (FCA) register before making any decisions about your pension. Don’t let anyone rush you into transferring or withdrawing your money. A genuine professional will never pressure you.
Saga has partnered with HUB Financial Solutions, who can help you find the right annuity for you from the whole of market. If you take out an annuity using their service, Saga Money will earn a commission.
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