Should I take my 25% tax-free lump sum?

Take it when you have a use for it that beats leaving it invested: clearing an expensive mortgage, funding the years before your State Pension, or a planned cost. Otherwise, taking 25% of each withdrawal tax-free as you go usually produces a lower lifetime tax bill, because the tax-free part keeps growing inside the pension and you only draw what you need.

Figures for the 2026/27 tax year · Published 2 October 2026

The tax-free lump sum is the most-asked-about part of any pension, and the most often taken by reflex at 55 because it is there. Three ways to use it, three very different outcomes.

The rules in one paragraph

You can take up to 25% of a defined contribution pot free of income tax, from the normal minimum pension age of 55 (57 from 6 April 2028). Across all your pensions the tax-free total is capped by the Lump Sum Allowance of £268,275, unless you hold a protection certificate for a higher amount. A final salary scheme offers its own lump sum, usually by giving up some pension at a commutation rate the scheme sets. Taking tax-free cash alone does not trigger the £10,000 Money Purchase Annual Allowance; taking taxable income from a pot does.

Option 1: all at once

You crystallise the whole pot, take 25% as a lump sum, and move the other 75% into drawdown. Every later withdrawal is fully taxable.

Alex has £400,000 at 60. Lump sum: £100,000, tax-free. The remaining £300,000 stays invested; everything drawn from it from now on is taxed as income. Once the State Pension starts at 67 and uses up the personal allowance, every pound Alex draws is taxed at 20% or more. Alex also has £100,000 in a bank account whose interest is taxable (above the £1,000 or £500 personal savings allowance), or in a GIA where dividends and gains are taxed, unless it is fed into ISAs at £20,000 a year.

Makes sense when: there is a mortgage at 5% to clear, a child’s deposit to fund, or a bridge to pay for and no ISA to pay it from. A guaranteed 5% saving beats an uncertain 5% return, tax-free.

Option 2: a slice with every withdrawal

Known as UFPLS. Each withdrawal is 25% tax-free and 75% taxable. Nothing is crystallised ahead of need, and the untouched pot, including its tax-free quarter, keeps growing.

Same Alex, same £400,000, wanting £25,000 a year net before the State Pension. A withdrawal of about £26,450 does it: £6,610 tax-free, £19,840 taxable, of which £12,570 is covered by the allowance and the rest taxed at 20% (about £1,450). Over the seven years to 67 Alex pays about £10,200 in tax. Under Option 1, drawing the same net income from the now fully taxable pot while the £100,000 sits in the bank, it is about £21,750. And the tax-free entitlement on the untouched pot keeps rising with growth, up to the £268,275 cap.

Makes sense when: you want income rather than a sum, you have no urgent use for a lump, and you want to keep options open. It is the default in Isaac for that reason.

Option 3: not yet

Leave the pot alone and live on ISAs, savings or earnings. The tax-free cash is still there later, and the whole pot compounds. The risk is the cap: if 25% of your pots grows past £268,275, the excess is taxable when taken. That starts to matter for pots above about £1.07 million; on £400,000 you have a long way to go. There is also the April 2027 inheritance tax change to weigh: leaving pensions untouched for the estate’s sake is less attractive than it was. Our guide to that change covers it.

Final salary schemes are a different question

A defined benefit scheme usually offers a lump sum by swapping pension for cash at a commutation factor. At 12:1 you give up £1,000 a year of inflation-linked income for life to get £12,000 now, which is poor value for most people who expect to live to 85; at 20:1 or more it can be reasonable. Some schemes give a lump sum automatically on top of the pension. Check your factor before you decide, and remember the income you give up would have been taxable, so the real cost is less than the headline.

The questions that decide it

• Do you have a specific use for the money that is worth more than tax-free growth?
• Will you still need income from the pot afterwards, and at what tax rate?
• Are you anywhere near the £268,275 cap, now or on a reasonable growth assumption?
• Would you be putting the cash somewhere taxable, and could you shelter it in ISAs fast enough?
• Might you go back to work and want to keep paying in above £10,000 a year?

If the answers are “no, yes, no, yes, maybe”, the slice-as-you-go route is usually the one. If there is a mortgage or a bridge to fund, the lump sum earns its keep. Model both before you sign the form; once crystallised, it does not uncrystallise.