How does the pension tax-free lump sum work?

Pension savings are one of the most tax-efficient ways to enjoy a rich and rewarding retirement - largely due to the tax-free lump sum.

In this guide, you'll learn how the tax-free lump sum works and what to consider before withdrawing your pension.

What is the pension tax-free lump sum?

The tax-free lump sum is a percentage of your total pension pot that can be withdrawn without tax. It applies to 25% of the total value of your pension, up to a limit.

The maximum you can withdraw tax-free is £268,275. This is known as the Lump Sum Allowance (LSA).

The Lump Sum Allowance replaced the Lifetime Allowance (LTA) in 2024. Older pension pots may be subject to LTA rules (more on that later).

How the Lump Sum Allowance works

Above the allowance

If your total pension pot is above the limit, you'll be taxed on the rest. For example:

Below the allowance

If 25% of your total pension pot is under the limit, there's no tax to pay on your lump-sum withdrawal.

Withdrawing your pension savings

When you withdraw your pension, how you access your money makes all the difference.

Types of pension withdrawals

There are three ways you can withdraw your pension. You can:

• take your entire pension as cash, or in smaller lump sums.
• buy an ‘annuity’ that staggers pension payments, so you receive installments like an annual salary.
• invest your pension, potentially growing your pot while withdrawing funds (known as ‘pension drawdown’ or ‘flexi-access drawdown’).

Whichever way you choose to withdraw your pension, you’ll have to consider how HMRC will tax your retirement funds.

If you withdraw your pension in one transaction, you’ll have to pay tax on anything over the 25% tax-free LSA.

Annuities provide a consistent income, giving you greater control over how much tax you pay.

When using drawdowns, it can help to withdraw little and often, supplementing your income with tax-efficient accounts like ISAs (Individual Savings Accounts).

If you're unsure which approach to take, consider speaking with a Financial Adviser.

The money purchase annual allowance

There are rules in place to stop people recycling money through their pensions to avoid paying taxes. In the UK, this is known as the money purchase annual allowance (MPAA).

The MPAA reduces the amount you can contribute to your pension after you start withdrawing from it. The limit is £10,000 per year. Above this, you’ll receive no more tax relief on pension contributions.

Exemptions to the pension tax-free lump sum

In some cases, you can access more of your pension without being taxed. These include:

Serious Ill-Health Lump Sum

If you’re diagnosed with a terminal illness and have not yet accessed your pension, you may be exempt from tax. This means you could withdraw your entire pension pot as a tax-free lump sum, depending on your circumstances.

If you're:

• Under 75, you won’t be taxed at all.
• Over 75, the lump sum is subject to Income Tax.

Withdrawing your entire pension as a tax-free lump sum could allow you to create priceless memories with loved ones. But Inheritance Tax will apply if funds remain when you pass away.

Instead, leaving some cash in your pension plan could be more tax-efficient when gifting money to children, or other people that aren’t your spouse. Spouses, including civil partners, are exempt from Inheritance Tax charges.

Primary, Enhanced, and Fixed Protection

Pension rules have changed over the years, which could affect how much you can withdraw as a lump sum. The exact amount depends on when you paid into your pension, as well as the type. 

If your pension was a LTA and enjoyed protected status, you may be able to withdraw more than the standard 25% tax-free lump sum.

There are three kinds of protected pensions. 

*Fixed protection totals vary as tax rules changed in 2012, 2014, and 2016.

Frequently asked questions about the pension tax-free lump sum

Is it worth taking a tax-free lump sum from my pension?

How you withdraw your pension affects the tax you pay.

For some retirees, taking the entire balance as a lump sum can help fund large purchases at the start of your retirement. But others benefit from taking smaller sums, or reinvesting to top-up their pension pots.

If you’re unsure which approach is right for you, consider speaking with a Financial Adviser.

Is the pension tax-free lump sum to be scrapped in 2024?

As of March 2025, there are no published plans to scrap the pension tax-free lump sum.

How much in savings can a pensioner have in the bank in the UK?

You can save as much as you like in a UK bank account. But over a certain amount, your interest will be taxed. Higher-rate taxpayers can earn up to £500 tax-free interest per year.

Find out more about growing your wealth with the complete guide to tax-free savings.

Do I have to declare my pension lump sum?

No, you do not have to declare your pension lump sum - even if it exceeds the £268,275 tax-free cap.

Pension withdrawals are treated as your income when you’re retired. Pension providers will hold back the amount of tax you owe, in the same way that employers automatically apply Income Tax for PAYE (Pay As You Earn) staff.

Understanding the pension tax-free lump sum

The pension tax-free lump sum is a portion of your total pension pot that you can take without paying money to HMRC. There are additional exemptions that may apply, for example where a pension is protected, or in cases of terminal illness.

You can take your pension as a one-off lump sum, or in smaller amounts. You may consider getting professional advice if you’re unsure which approach is better for you.

Grow your wealth with high-interest savings accounts

Enjoy your retirement on your own terms by growing your savings in multiple, high-interest savings accounts.

Compare interest rates and create a cash portfolio, all in one platform.

DISCOVER HOW IT WORKS