In certain circumstances, you or your beneficiaries may be able to take a tax-free lump sum of up to £1,073,100. Examples include if you take a lump sum due to serious illness or your beneficiaries receive lump sum death benefits. This is called the lump sum and death benefit allowance.
You could also get a higher allowance if you have a valid protection certificate.
Mike Haynes, head of employment and pensions at tax advisory firm Andersen LLP, said: “For those who previously applied for fixed protection, individual protection or enhanced protection, their lump sum allowance may be calculated on the old lifetime allowance that existed previously. This will potentially give access to tax free benefits higher than £268,275.”
It’s important to keep track of how much you’ve withdrawn from your pension pot tax-free so that you know how much you can still take – and how much tax you will need to pay on the rest.
Ian Cook, financial planner at Quilter Cheviot, said: “You can review pension statements, check with your pension provider, or consult with a financial adviser to calculate your remaining pension allowance. Many online pension calculators can also help provide estimates.”
There are several ways to take your tax-free lump sum, depending on your preferences:
1. Take only the tax-free lump sum
You could choose to only take the 25pc tax-free lump sum, leaving the remainder of your pension invested. When you withdraw the remaining funds, they will be taxed as income. You could do this through pension drawdown or use the funds to buy an annuity.
2. Take less than the tax-free cash
If you don’t want to take all your tax-free cash at once, you don’t have to. You can withdraw the amount you need and leave the remainder to be taken at a later date. If your pension pot increases in value, you could have a larger tax-free amount to withdraw later.
3. Take your whole pension fund, including the tax-free cash
Another option is to withdraw your full pension in one go. If you do this, 25pc will be tax-free and tax will be due on the remainder. This could be at a higher rate of income tax.
However, before going down this route, consider whether you have sufficient funds to support you throughout retirement – perhaps through investments or another source of income. If you don’t, it may not be the best choice.
4. Take a lump sum, with 25pc tax-free
If you’ve not yet touched your pension at all, there’s also the option of an uncrystallised funds pension lump sum (UFPL). This is where you leave your pension invested and make withdrawals as required.
With each withdrawal you make, 25pc is tax-free and you pay tax on the rest. This gives you the advantage of being able to spread your tax-free benefit over several withdrawals.
If you’re unsure which option is best for your personal and financial circumstances, you should seek financial advice. It’s also wise to check the specific rules of your pension scheme.
Timing is key when it comes to taking your lump sum and maximising your tax benefits.
Mr Cook explained: “If you are nearing retirement but still earning, withdrawing a large sum could push you into a higher income tax bracket. To maximise tax efficiency, consider spreading withdrawals across tax years or using pension drawdown to balance your income needs and tax liability.
“Seeking advice can help ensure that you do this in the most tax efficient way at the optimal time.”
Is the 25pc tax-free pension lump sum under threat?
Possibly – the Institute for Fiscal Studies (IFS) has urged Chancellor Rachel Reeves to reduce the lump sum allowance to £100,000 to raise around £2bn a year for the Treasury. However, such changes are likely to prove unpopular and may not take effect immediately.
