How the 25% tax-free rule works, the limits that apply, and what happens when you take more.
When you access a defined contribution pension — the kind you build up through a workplace or personal scheme — you usually have the option to take cash as a lump sum. How much tax you pay depends on the size of the lump sum and how it fits with the rest of your income for the year.
Most people get a quarter of their pension pot tax-free. The remaining three-quarters is treated as income and taxed at your marginal rate for that year, just like a salary.
That example assumes no other earnings. If you are still working or have other income, the taxable part of the lump sum is added on top, which can push you into a higher tax band for the year.
For most defined contribution pensions, the tax-free element is capped at 25% of the value of your pension rights. This is sometimes called your Pension Commencement Lump Sum (PCLS).
If you have a defined benefit (final salary) pension, different rules apply. Your scheme will typically offer a tax-free lump sum calculated using a formula set out in the scheme rules — often up to 25% of the capital value, but the exact figure depends on your pension factor and length of service.
There is a lifetime limit on the amount of tax-free pension lump sums you can receive across all your pensions. This is called the Lump Sum Allowance (LSA).
The LSA is calculated as 25% of the standard lifetime allowance, which was fixed at £1,073,100 in 2024. Most people therefore have an LSA of £268,275. If you had protections in place before the lifetime allowance was abolished, your LSA may be higher — this depends on the specific protection you hold.
There is also a separate Lump Sum and Death Benefit Allowance (LSDBA), which covers both the tax-free lump sums you take in your lifetime and certain lump sums paid to your beneficiaries when you die. The standard LSDBA is £1,073,100, again subject to any protections you hold.
Some schemes let you cash out your entire pension in one go, rather than buying an annuity or moving into drawdown. In that case:
Taking a large lump sum can push you into the higher rate band for that single year, even if your normal income is modest. It is often worth considering whether spreading withdrawals over several tax years would leave you with more money overall.
If you take more than your tax-free lump sum out of a defined contribution pension — for example, by moving into drawdown or taking an uncrystallised funds pension lump sum (UFPLS) — the Money Purchase Annual Allowance (MPAA) is triggered.
Once triggered, the amount you can pay into defined contribution pensions each tax year with tax relief drops significantly. The MPAA is a fixed figure set in legislation, and it applies regardless of your earnings. If you plan to keep building your pension after accessing it, check the current MPAA before you take any taxable income.
There are special rules for small pension pots, which allow you to take the whole pot as cash without triggering the MPAA:
These rules let you clear out small pensions without losing your full annual allowance for future contributions.
If you die before age 75 and you have not yet taken your pension, the lump sum paid to your beneficiaries is usually tax-free, provided it is paid within two years. After age 75, death benefits are taxed at the beneficiary's marginal rate.
If you have already moved into drawdown, any unused funds can be passed on. The tax treatment depends on whether you had taken the tax-free element and on the age at death. The Lump Sum and Death Benefit Allowance applies to certain payments, and amounts above it are taxed accordingly.
Because the tax on a pension lump sum is calculated against your income for the whole tax year, timing matters. Consider: