RetirePlan

The 25% Tax-Free Lump Sum

One of the most widely known — but often misunderstood — features of UK pensions is the ability to take part of your pot tax-free. While this “25% rule” is still in place, the rules have evolved since the Lifetime Allowance was abolished.

What Is the Tax-Free Lump Sum?

Most UK pension savers can take up to 25% of their pension pot tax-free when they begin accessing their benefits.

This is known as the:

Pension Commencement Lump Sum (PCLS) for Defined Contribution pensions
Or a commuted lump sum in Defined Benefit schemes

The rest of the pension is either used to provide a taxable income or is left invested.

How Much Can You Take Tax-Free?

Under the post-2023 rules, the tax-free lump sum is capped — even if your pension pot is very large.

Standard Limit:

25% of your pension value, up to a maximum of £268,275

This is based on 25% of the former Lifetime Allowance of £1,073,100.

What If You Have Lifetime Allowance (LTA) Protection?

If you applied for LTA protection in the past (e.g. Fixed Protection 2016, Individual Protection 2014, etc.), you may be entitled to a higher tax-free lump sum.

In some cases, this could be £300,000 or more
You will need to provide evidence of protection to your scheme

Even though the LTA is abolished, the protection still preserves tax-free cash rights

When Can You Take the Lump Sum?

You can normally take your tax-free lump sum:

From age 55 (rising to 57 from 2028)
When you first crystallise your pension — i.e. begin drawdown, take an UFPLS payment, or buy an annuity

You don’t have to take it all at once — in drawdown, you can phase it over time.

How It Works in Different Pension Types

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Defined Contribution (DC) Pensions

You can take 25% tax-free:
- As a single lump sum
- Or as part of each withdrawal (e.g. via UFPLS or phased drawdown)
The remainder is taxed as income when withdrawn

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Defined Benefit (DB) Pensions

The scheme calculates a lump sum based on commutation
You give up some annual income in exchange for a tax-free lump sum
Commutation rate varies (e.g. £15:1 or £20:1)

The 25% limit still applies based on the capitalised value of the pension — not just the annual amount

What Happens If You Exceed the Limit?

If you try to take more than £268,275 tax-free (without protection), the excess will be taxed as income. This typically applies to:

Very large pension pots
DB scheme members with generous commutation terms

Can You Use the Lump Sum Tax-Efficiently?

Yes — here are some smart uses:

T3.4.1 – Lump Sum Uses

Use Case	Why It Works
Pay off mortgage or debt	Saves interest and frees up monthly income
Invest tax-efficiently	E.g. ISAs, or back into pensions (if under annual limit)
Gift to family	Could reduce your estate for IHT purposes
Build emergency fund	Helps manage unexpected costs in retirement
Delay income withdrawals	Helps reduce income tax in early retirement years

⚠️ Be mindful of the Money Purchase Annual Allowance (MPAA) if you take taxable income later — it may reduce how much you can contribute going forward.

📋 Summary: Tax-Free Lump Sum Rules

T3.4.2 – Summary

Pension Type	Available?	How It’s Calculated	Max Without Protection
DC	Yes	25% of pot value at crystallisation	£268,275
DB	Yes	Based on scheme commutation rules and value	£268,275
With LTA protection	Yes (possibly more)	Depends on protection type and pension size	Can exceed £268,275
Partial access	Yes	Phased via drawdown or UFPLS	Still capped in total

Next Chapter Preview:

We’ll explore pension tax traps and planning tips — including the Money Purchase Annual Allowance (MPAA), marginal rate risk, and how to avoid common mistakes when drawing income.

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3.4 The 25% Tax-Free Lump Sum