The Pension Tax-Free Lump Sum Explained

Pension tax-free lump sum is the name given to the amount of your pension pot that you can withdraw when you access your pension without needing to pay income tax. It might also be referred to as your pension commencement lump sum.

Ruth Jackson-Kirby, Tim Leonard Last updated on 28 April 2022.
The Pension Tax-Free Lump Sum Explained

The pension tax-free lump sum refers to the amount of your pension savings you can take as a tax-free lump sum when you take benefits from your pension. You don’t have to take it all at the same time, and you don’t have to take it at all. Examples of this could include if you would prefer to use your funds to buy an annuity or if you want to enter a pension drawdown arrangement for only a portion of your pension's full value. It’s important to consider carefully all of your options for cashing in your pension at retirement.

What is a pension tax-free lump sum?

When you take money from your pension it will usually be added to your income and taxed at your marginal rate. However, you can also take up to 25% of it tax-free – this is called the pension tax-free lump sum, or the pension commencement lump sum (PCLS).

The rules surrounding the tax-free cash you can take will depend on the type of pension you have and your pension provider. Typically, if you have a defined contribution pension you can take up to 25% of it tax-free once you turn 55.

How can I take my pension tax-free lump sum?

Generally, you don’t have to take your entire PCLS as one lump sum. You can take it as a series of smaller sums until you hit your 25% limit. However, your tax-free cash can only be taken at the point of ‘crystallisation’, where your pension is accessed in order to provide retirement benefits – in other words, when you’re going into drawdown or purchasing an annuity.

If you’re not ready to do this but still want access to cash lump sums this is possible using the so-called ‘uncrystallised pension fund lump sum’ rules. Here you can make cash withdrawals as and when you need and leave your remaining funds untouched in your pension. The difference is that only the first 25% of each withdrawal is paid tax-free and the remainder is subject to tax at your personal rate.

If you have a defined benefit pension, or final salary pension, the rules are set by your pension provider. You will need to contact them to find out if the scheme allows tax-free cash to be withdrawn and how much this might be.

Should I take out a tax-free lump sum from my pension?

There are a number of reasons why you might take a tax-free lump sum out of your pension. However, just because you can take your PCLS from the age of 55, it doesn’t mean you have to. If you don’t need the funds immediately, you could leave your pension to grow and take your lump sum at a later date. Alternatively you might never take it all and prefer to use the money to boost your retirement income instead.

Among the reasons you might take a tax-free lump sum, clearing the last of your mortgage or other debts in order to reduce your outgoings in retirement are often towards the top of the list. Or it may be that you need a new car or want to make home improvements.

When you might think twice is if you intend to simply put your tax-free pension cash into a cash ISA or savings account. Cash savings offer the advantage of protecting your funds from stock market falls, but with interest rates still relatively low, the potential for growth remains higher if your money is still invested in your pension, although this is not guaranteed.

Ultimately the decision to access pension benefits is a personal choice and one with many factors that could influence what is best for your individual circumstances. You may wish to seek professional advice from a financial adviser to ensure you make a suitable decision based on your retirement needs.

» MORE: The crucial role of pension funds in retirement

How to get a lump sum from your pension

If you want to take a tax-free lump sum from your pension, speak to your pension provider to check if it’s an option for you. If you’re not allowed, you could consider transferring your pension to another scheme where you can. There is a risk that you’ll lose valuable benefits from your old pension in the process, so seeking advice is sensible – and sometimes an obligation – before you transfer.

If taking tax-free cash from your pension is an option, check with your provider if there are any fees and charges you may have to pay to access your lump sum and ask them about the process.

Can I take my pension tax-free lump sum before age 55?

Generally, you must be over 55 in order to access your pension, but there are exceptions where you may be allowed to take your tax-free lump sum (or even your entire pension) earlier.

These might include if:

  • You’re in ill health and are allowed to retire early
  • You have a life expectancy of less than a year and your pension is under the lifetime allowance
  • Your job has an early retirement age, perhaps because you’re a sportsperson

If none of these exceptions apply and you take tax-free cash from your pension pot before age 55 you could face a 55% tax charge and perhaps penalty fees from your pension provider.

If you are contacted by anyone saying they can help you access your pension early it is likely to be a pension scam.

Pros and cons of taking a tax-free lump sum

There is a lot to consider before you start taking money out of your pension – even if it is tax-free.

How pension lump sum rules can work to your benefit

  • You are free to choose what you do with your money.
  • You can pay off any outstanding debts you might have like your mortgage.
  • You can raise the funds for larger expenses like home improvements or a new car.
  • You can reduce your pension’s exposure to investment risk.

Why taking a pension tax-free lump sum might not be a good idea

  • You reduce the size of your total pension and run the risk of running out of money in retirement.
  • Taking money out of your pot reduces the level of income the remaining capital may be able to generate.
  • You miss out on further investment growth on that money.
  • Your money generally remains sheltered from inheritance tax while it is in your pension.

Where can I go for pension advice?

Working out how best to access your pension is a hugely important decision that can have financial repercussions for the rest of your life. If you feel you only need basic guidance, everyone aged over 50 with a pension is entitled to a free pension consultation with the government’s Pension Wise service.

However, this service only provides generic guidance, for tailored advice based on your particular situation it is best to seek advice from a financial adviser, who can explain your options and help choose a suitable course of action.

» MORE: How to get pension advice

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About the authors:

Ruth is a freelance journalist with 15 years of experience writing for national newspapers, magazines and websites. Specialising in savings, investments, pensions and property. Read more

Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more

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