What is the pension tax-free cash lump sum, when can you take it and how much can you take?
You can usually take up to 25% of your pension money without paying any tax. This is called a tax-free lump sum or it’s also known as tax-free cash. Currently, you can access money in your pension from age 55, but this will increase to age 57 from 6 April 2028.
There is a maximum amount that most people can take tax-free, which is £268,275.
If you have a defined contribution pension pot, where you and your employer (if you have one) have paid into and built up savings for your retirement, then there are three options for accessing tax-free cash:
- Drawdown (also known as flexible access): Take 25% tax-free cash and move the other 75% into drawdown (sometimes called income drawdown). This means that your pension savings stay invested. This is a popular choice for people who are still working and don’t want to take money out of their pension that they will have to pay tax on, as you don’t need to take money out of drawdown immediately. When you’ve taken your whole tax-free cash lump sum, any other money you take out is taxable.
- Annuity (also known as secure access): Take 25% tax-free cash and use the other 75% to purchase a guaranteed, secure income for the rest of your life. The income you receive from the annuity is taxable.
- Cash lump sum: Here you can take lump sums out of your pension as and when you need to, or you can cash it all in. In this case, 25% of every payment you receive will be tax-free, and the other 75% will be taxable.
You can find out more information about how to take money from your defined contribution pension in our guide on retirement options.
If you are a member of a defined benefit pension, which can also be known as a final salary or career average pension, your employer promises to pay you a guaranteed income in retirement. They will often pay an income to your spouse or partner after you have died, as well. The amount you get is based on how long you worked for your employer and how much you earned. Normally, you need to retire before you can take tax-free cash from your pension. And, unlike with a defined contribution pension, you have to receive your monthly taxable pension income at the same time.
Is the 25% tax-free cash lump sum under threat?
You may have heard rumours that the amount you can take out of your pension tax-free is under threat. This is not the first time these rumours have started as before the Autumn 2024 Budget there was a lot of speculation in the media about tax-free cash being reduced. However, this didn’t happen. Similar rumours often surface before every Budget.
Some people took all the tax-free cash they were entitled to last year in anticipation of a change. But this decision can’t usually be reversed. Once the money is taken out of your pension, you can’t put it back in, and it might instead simply stay in a bank account. Unless you have put your pension tax-free cash lump sum in a Cash ISA, you’ll pay tax on the interest earned in a bank account, depending on your income tax rate.
For example:
- Basic rate taxpayers can earn £1,000 of interest tax-free in a tax year
- Higher rate taxpayers can earn £500 of interest tax-free in a tax year
- Additional rate taxpayers don’t have any tax-free interest allowance.
If the tax-free cash lump sum you withdrew was large, you might need to pay tax on the interest. When money stays in your pension then it can grow without tax being paid, and you only pay tax when you withdraw more than your tax-free cash allowance.
Should you take out tax-free cash now?
Think carefully about taking money out of your pension – especially if you don’t need it right now. Keeping it invested could help it to grow for your future. Taking your tax-free cash now and spending it, could leave you with less money in retirement.
When there have been reductions to tax-free cash in the past, people who already had a right to the higher amount kept that right. This is because changes in law normally only apply to action taken in the future.
Can you take tax-free cash from more than one pension?
One question we often get asked is whether someone who has more than one pension can take tax-free cash from each of them. The answer is that, yes, you can take up to 25% from each pension you have as tax-free cash.
Let’s look at an example. Mona has four defined contribution pensions.
| Pension value | Amount of tax-free cash available |
| £15,000 | £3,750 |
| £10,000 | £2,500 |
| £20,000 | £5,000 |
| £50,000 | £12,500 |
However, you can’t take the total amount from one of them. So, in the example above, Mona couldn’t ask for £23,750 to come out of her largest pension pot.
Do you have to take tax-free cash in one go?
If you are a member of a defined benefit (for example, final salary) pension, you’ll need to take your tax-free cash in one go.
If you are a member of a defined contribution pension (where you build up a pot of pension savings), you have more freedom. It all depends on what you want the money for.
For example, you could use your 25% tax-free cash, taken in stages, to provide a tax-free income – either on top of your earnings or to fill in the gap while you wait to be able to claim the State Pension. Or you might have several planned expenses that you could use the full amount of tax-free cash to pay for.
Taking tax-free cash in stages could help your pension pot grow, giving you more money to enjoy in the future. For example, if you have a pension pot of £100,000 and take £10,000 of tax-free cash and move £30,000 into drawdown, that leaves a pension pot of £60,000. If, in five years, that pension pot grows to £70,000, you could take £17,500 tax-free cash and move the other £52,500 into drawdown. That’s a total of £27,500 tax-free cash. If you had taken all your tax-free cash at the beginning, you would have been entitled to £25,000 tax-free cash while £75,000 moved to drawdown.
However, returns are not guaranteed and if your pension pot decreased in value then you’d be entitled to 25% of the lower amount.
Before 2011, you had to take tax-free cash before the age of 75. There isn’t a legal rule about this now, but many people still take it before this age. That’s because if you die when you’re 75 or over, the people who inherit your pension would need to pay income tax on any pension money they inherit, and the right to tax-free cash is lost.
Financial advice
Before you make any decisions about your pension it might be worth taking financial advice. You might be thinking about tax-free cash but there are decisions that need made about the rest of your pension money too.
For more information, have a look at our guide Getting financial advice - Royal London.
