You can take different tax-free lump sums from your pension pot depending on the type of protected allowances you hold.
Generally, you can take a tax-free lump sum from your pension of 25% of your pension pot, up to a maximum across all your arrangements of £268,275. This is your lump sum allowance.
Both are tax-free up to a maximum of £1,073,100. This is your lump sum and death benefit allowance.
Any tax-free lump sums and lump sum death benefits will count towards your overall limit of £1,073,100.
If you have protected allowances, the amount of tax-free lump sum you can take and your overall tax-free limit may be higher. Your entitlement amount depends on the protection or enhancement that you hold.
You may have a protection cessation event that means you are no longer entitled to protected allowances. In this case, you will also no longer have entitlement to a higher tax-free lump sum and higher lump sum and lump sum death benefit allowance.
You can only take a maximum of 25% of your pension pot, even if you have a higher amount of tax-free lump sum available.
You can keep the lump sum protection that is written on your protection certificate as long as you have valid enhanced protection with lump sum protection. This means you can get a tax-free lump sum equal to the value of the safe percentage of your pension plans on April 5, 2023.
For example, if you hold enhanced protection with lump sum protection of 40% and the value of your pension pots on 5 April 2023 is £1. 6 million, you are entitled to a tax-free lump sum of up to £640,000.
For example, you’re entitled to a tax-free lump sum of up to £640,000 if both of the following apply:
Any contributions made after 5 April 2023 will not be included in the calculation for your increased tax-free lump sum.
It is possible to get a tax-free lump sum of up to £375,000 if you have valid enhanced protection but not lump sum protection.
Are you thinking about taking out a lump sum from your retirement savings? If so, you may be wondering how much you can get without having to pay taxes on it. Well, I have all the information you need to know about the rules for taking money out of your pension and how to get the most tax-free cash without getting hit with a surprise tax bill.
The Basic Rules of Tax-Free Pension Lump Sums
First things first – most people can take up to 25% of their pension pot as a tax-free lump sum. This is pretty standard across different pension schemes. But (and there’s always a but), there’s an overall limit on how much you can take tax-free in total.
Beginning in 2025, the “lump sum allowance” (LSA) limits the amount of tax-free cash that an individual can have. The standard LSA is currently £268,275. This number is the twenty-five percent of the old lifetime allowance that was taken away on April 6, 202024.
Before I dive deeper let’s clarify what this means
- You can usually take 25% of your pension as tax-free cash
- There’s a maximum cap of £268,275 for most people
- Some folks might have a higher allowance if they’ve got special protections (more on that later)
When Can You Take Your Tax-Free Lump Sum?
You can normally access your tax-free cash from the normal minimum pension age (currently 55), although this is set to rise to 57 in 2028. In some cases, you might be able to take it earlier if:
- You’re retiring due to ill health
- You’ve got a protected low pension age (rare, but happens)
Important to note: Tax-free cash normally can only be paid if you’re also bringing your pension benefits into payment at the same time. This is why it’s officially called a pension commencement lump sum (PCLS).
Transitional Protections and Higher Allowances
Some lucky people may be able to get more than the standard limit of £268,275 in tax-free cash. If you’ve got one of these protections you’re sitting pretty .
| Type of Protection | Lump Sum Allowance |
|---|---|
| Fixed Protection 2016 | £312,500 |
| Individual Protection 2016 | Lower of: 25% of benefits on 5 April 2016 or £312,500 |
| Fixed Protection 2014 | £375,000 |
| Individual Protection 2014 | Lower of: 25% of benefits on 5 April 2014 or £375,000 |
| Fixed Protection 2012 | £450,000 |
| Enhanced Protection | £375,000 (unless registered tax-free cash applies) |
| Primary Protection | £375,000 (unless registered tax-free cash applies) |
You can get a lot more tax-free cash if you have these protections. They’re like golden tickets. If you think you might have one, get out your old pension papers or talk to a financial advisor.
Tax-Free Cash from Different Types of Pension Schemes
Defined Contribution Schemes
For defined contribution pensions (like personal pensions or SIPPs), the calculation is fairly straightforward. You can typically take up to 25% of your pot as tax-free cash. So if you’ve got £200,000 saved up, you could take £50,000 tax-free, subject to staying within your overall LSA.
Defined Benefit Schemes
For defined benefit (final salary) schemes, things get a bit more complex. Tax-free cash is commonly provided by one of two methods:
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Commuting pension for cash – You give up part of your pension in exchange for a lump sum. For example, the scheme might offer £15 of tax-free cash for every £1 of annual pension you surrender.
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Separate lump sum – Some schemes (particularly public sector ones) provide a defined level of tax-free cash, such as 3/80ths of your final salary for each year of membership, without reducing your pension.
Here’s a real-world example to make this clearer:
Tanya is retiring from her DB pension scheme at age 60. Her final salary is £30,000, giving her a pension of £20,000 a year. Her scheme allows her to commute part of this pension for tax-free cash at a rate of £15 for each £1 of pension given up.
The maximum tax-free cash Tanya can take is £92,307. If she takes this, her annual pension will reduce to £13,846.
What Happens If You Want More Than The Tax-Free Amount?
If you want to take more cash than your available tax-free lump sum allowance, you can still do so, but the excess will be subject to income tax at your marginal rate.
For defined benefit schemes, this is known as a ‘pension commencement excess lump sum’ (PCELS). For defined contribution schemes, the excess is typically paid as an ‘uncrystallised funds pension lump sum’ (UFPLS) which is partly taxable.
U.S. Tax Rules for Lump Sum Distributions
If you’re in the U.S., the rules work differently. The IRS has specific provisions for “lump-sum distributions” from qualified retirement plans or retirement annuities.
To qualify as a lump-sum distribution in the U.S., the payment must be:
- The entire balance from all the employer’s qualified plans of one kind
- Paid because of the plan participant’s death, after reaching age 59½, because of separation from service, or due to disability (if self-employed)
U.S. taxpayers born before January 2, 1936, might be eligible for special tax treatment options, including:
- Capital gain treatment for pre-1974 participation
- The “10-year tax option”
- Rollover options to defer tax
Recipients of lump-sum distributions in the U.S. should receive a Form 1099-R from the payer showing the taxable distribution and any amount eligible for capital gain treatment.
Gift Tax Considerations for Cash Lump Sums
It’s worth noting that if you’re planning to give away some of your tax-free lump sum to family members, there may be gift tax implications.
In the U.S. for 2025, you can give gifts of up to $19,000 to as many people as you want without any tax or reporting requirements. Amounts above this may require filing Form 709, although there’s also a lifetime exclusion of $13.99 million.
As Scott Sturgeon, senior wealth advisor and founder of Oread Wealth Partners, puts it: “Gifting cash to family members can be a significant component of an overall estate plan.”
How Previous Benefit Withdrawals Affect Your Remaining Tax-Free Cash
If you’ve already taken benefits from your pension before April 6, 2024, your available LSA might be reduced. There are two ways to calculate this:
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Standard calculation – Your LSA is reduced by 25% of the lifetime allowance that was used up by previous benefit crystallizations.
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Alternative calculation – If you can prove exactly how much tax-free cash you’ve already received, you might be able to apply for a ‘transitional tax-free amount certificate’ (TTFAC), which could potentially give you more remaining LSA.
Who Should Consider Getting a TTFAC?
The alternative calculation might benefit you if:
- You took low or no tax-free cash (perhaps because your scheme had generous guaranteed annuity rates)
- You were in a DB scheme but didn’t commute pension for your full tax-free cash entitlement
- You took benefits during 2016-2020 when the LTA was lower
- You transferred uncrystallised benefits to a QROPS
- You’re over 75 with unused funds
Tips to Maximize Your Tax-Free Cash
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Check if you have any form of protection – If you do, you could be entitled to more tax-free cash.
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Consider consolidating pensions – But be careful! Some older pensions might have valuable guarantees or higher tax-free cash entitlements.
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Think about phasing your withdrawals – You don’t have to take all your tax-free cash in one go. Phasing can sometimes be more tax-efficient.
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If you have DB and DC pensions, plan carefully – The rules about where to take tax-free cash from first can be complex and might affect how much you can get.
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Consider applying for a TTFAC if appropriate – This needs to be done BEFORE taking any benefits after April 6, 2024.
The maximum tax-free lump sum is typically 25% of your pension, capped at £268,275 for most people (or higher with protections). But just cos you CAN take this much, doesn’t mean you SHOULD!
Taking your tax-free cash is a big decision that could affect your income for the rest of your life. I always recommend getting professional financial advice before making any significant pension decisions.
Remember – your pension needs to last as long as you do, so think carefully about how much cash you really need upfront versus maintaining a sustainable income throughout your retirement.
Have you started planning how much tax-free cash you’ll take from your pension? I’d love to hear your thoughts in the comments below!
Lump sum and lump sum death benefit allowance
If you have valid primary protection, the amount of your lump sum and lump sum death benefit is less than or equal to
- how much all of your pensions were worth on April 5, 2006
- £1.5 million
You may have a pension debit applied from a pension sharing order that results in value of your pension pot going below £1. 5 million. If so, your increased tax-free lump sum will revert to 25% of the standard lifetime allowance.
If you hold valid:
- If you have fixed protection, you can get a lump sum of up to £450,000 tax-free.
- If you have fixed protection 2014, you can get a lump sum of up to £375,000 tax-free.
- If you have fixed protection 2016, you can get a lump sum of up to £312,000. This is tax-free.
Pension debits applied from pension sharing orders
If you have a pension deduction that lowers the value of your pension pot below the minimum value needed for protection, your tax-free lump sum will go back to the top 25% of your pension pot, up to a maximum of $2,268,275. Your lump sum and death benefit allowance will revert to £1,073,100.
If you hold a valid enhancement factor that is valid on or before 5 April 2024, you may have entitlement to higher allowances.
You may have an enhancement factor from pre-commencement pension credit rights. In this case, your lump sum payment will be 25% of your pension pot, up to a maximum of $3375,000.
You may hold one or more enhancement that is from:
- pre-commencement credit rights
- Pension Credit rights from previously crystallised rights
- non-residency
- transfers from a recognised overseas pension scheme
If so, your lump sum and death benefit allowance will be equal to £1,073,100 plus the value of your enhancement factor against £1,073,100.
For example, if you have an enhancement factor of 0.15, your lump sum and death benefit allowance will be £1,234,065. This is because the factor of 0.15 against £1,073,000 is £160,095. This value added on to £1,073,100 equals £1,234,065.
You may hold a protection that means you have a higher lump sum and death benefit allowance. If so, your overall allowance will be both your:
- protected allowance
- the value of your enhancement factor against your protected allowance
For example, if you hold Individual Protection 2014 at £1.3 million and a factor of 0.23, your overall lump sums and death benefits allowance would be £1,599,000. This is because the factor of 0.23 against £1.3 million is £299,000. This value added on to £1.3 million equals £1,599,000.
The surprising reasons why you shouldn’t take the tax free cash from your pension
FAQ
How to avoid taxes on a lump sum payout?
Transfer or rollover options You may be able to defer tax on all or part of a lump-sum distribution by requesting the payer to directly roll over the taxable portion into an individual retirement arrangement (IRA) or to an eligible retirement plan.
How much of lump sum payout is tax-free?
Retirement fund lump sum benefits or severance benefitsTaxable income (R)Rate of tax1 – 550 0000% of taxable income550 001 – 770 00018% of taxable income above 550 000770 001 – 1 155 00039 600 + 27% of taxable income above 770 0001 155 001 and above143 550 + 36% of taxable income above 1 155 000.
What is the 6% rule for lump sum?
The 6% Test If your monthly pension payout is 6% or higher, the monthly pension could be a solid option. If the monthly pension payment is less than 6%, the lump sum amount, which can be put into a retirement account, may give you more financial freedom.
Can you take a tax-free lump sum every year?
Yes. Usually, 25% of each payment is tax free. The other 75% of each lump sum you take will be treated as income so you may pay tax on it at your highest rate.
What is a tax free lump sum?
There is a maximum amount that can be taken as a tax free lump sum which is set by HM Revenue and Customs, which is 25 per cent of the capital value of your pension benefits or if lower, 25 per cent of your remaining lifetime allowance. For every £1 of pension you exchange you then receive £12 as a tax free lump sum. Are lump sum benefits tax-free?.
How much tax-free lump sum can I take?
From 6 April 2023, the amount of tax-free lump sum you can take is 25% of your pension pot, up to a maximum of 25% of the standard lifetime allowance. The current lifetime allowance is £1,073,100. If you have certain lifetime allowance protections, you may be able to take a bigger tax-free lump sum.
What is a tax-free lump sum allowance?
Standard Tax-Free Lump Sum Allowance: Generally, you can take a tax-free lump sum from your pension of 25% of your pension pot, up to a maximum across all your arrangements of £268,275. This is your standard lump sum allowance.
What are the tax implications of a lump sum payment?
There are a few things you should think about when you get a lump sum payment, especially if it comes from a qualified retirement account. Here’s how to figure out your taxes: For federal taxes, use your total income, including the lump sum, to find your tax bracket. Apply this percentage to the lump sum to estimate the federal tax.
Do you pay taxes on a lump sum?
State Income Taxes: Similar to federal taxes, apply your state’s income tax rate to the lump sum. This varies by state. Early Withdrawal Penalty: If you’re under 59.5 years old and withdrawing from a qualified retirement account, add a 10% penalty to the taxable amount. 1. Lump Sum From a Traditional IRA or 401 (k): Taxed as Ordinary Income
Should I take out a tax-free lump sum?
Just take the tax-free cash – you take out a tax-free lump sum (you can normally take up to 25% of any funds as a tax-free lump sum, as long as this amount is not higher than your available allowances) and leave the rest invested until you decide to make more withdrawals or set up a regular income. How do I avoid taxes on lump sum payout?