The 25% Pension Tax-Free Lump Sum Explained (2025/26)

Quick answer

When you retire (currently from age 55, rising to 57 from April 2028), you can take 25% of each pension pot tax-free. The remaining 75% is taxed as income when withdrawn.

The 25% tax-free withdrawal is capped by the Lump Sum Allowance (LSA) — £268,275 for 2025/26. This is the maximum total tax-free pension lump sum you can take in your lifetime, across all pensions.

For most UK retirees, the 25% withdrawal will be well under the LSA. The cap only bites for those with pensions over £1,073,100 total.

Worked example — Sarah, £500,000 pension at age 60

Sarah has a £500,000 SIPP at age 60 in 2026/27. She decides to take the 25% tax-free portion as a lump sum.

• Tax-free lump sum: 25% × £500,000 = £125,000. No tax due.
• Remaining pot: £375,000 (75%), goes into drawdown.
• LSA used: £125,000 of £268,275 (still £143,275 of headroom).

Sarah's lump sum is well within her LSA. She uses £80,000 to clear her mortgage and keeps £45,000 as a cash buffer. Net position: mortgage-free, with £375,000 still invested for drawdown.

Worked example — Mark, £1.5m pension at age 65

Mark has £1.5m across two SIPPs.

• Theoretical 25%: £375,000.
• LSA cap: £268,275.
• Actual tax-free: £268,275 (capped).
• Remaining £1,231,725 is taxed as income when withdrawn (basic / higher / additional rate depending on his other income that year).

Mark's withdrawal strategy matters more because of the cap. Spreading withdrawals across multiple tax years keeps him in lower bands.

What was the Lifetime Allowance?

Until April 2024, there was a Lifetime Allowance (LTA) capping the total tax-favoured pension wealth at:

• £1.5m (2014-15)
• £1.25m (2014-16)
• £1m (2016-18)
• £1,073,100 (2020-24)

Pension wealth over the LTA was taxed at penal rates: 25% (income) + 55% (lump sum). Higher earners often deliberately stayed below the LTA to avoid the charge.

The April 2024 abolition was a major liberalisation. In its place, two new allowances:

Both are lifetime allowances across all your pensions.

The LTA's removal benefited high earners — NHS consultants, senior public-sector workers, finance directors — who could now build pots larger than £1,073,100 without the 25%/55% surcharge.

Three ways to take the 25%

You can structure your tax-free withdrawal in three main ways:

1. Full 25% upfront, then drawdown

Take the full 25% of the pot as a single tax-free lump sum. The remaining 75% goes into "drawdown" and is invested. You take income from it as needed, taxed at your marginal rate.

Pro: Maximum immediate cash for big purchases (mortgage, helping kids, etc.). Con: Loses tax-free status of money that stays in drawdown — future growth is taxable.

2. Uncrystallised Funds Pension Lump Sum (UFPLS)

Each withdrawal is 25% tax-free + 75% taxable. So a £10,000 withdrawal = £2,500 tax-free + £7,500 taxable.

Pro: Spreads tax-free element across many withdrawals. More tax-efficient if you only need partial access. Con: Complex tracking; HMRC reporting.

3. Annuity with tax-free cash

Take 25% as a tax-free lump sum, use the remaining 75% to buy an annuity (guaranteed income for life). The annuity payments are taxable as income.

Pro: Income certainty. Con: Annuity rates have improved 2023-25 but still typically less generous than drawdown for active investors.

When 25% strategy matters

For most UK retirees with modest pensions (£100k-£500k), the strategy:

1. Don't take the 25% just because you can. Money left in the pension grows tax-free.
2. Only take it if you have a specific use. Paying off a high-interest mortgage, helping kids onto the property ladder, taking a once-in-a-lifetime trip — clear value.
3. Avoid taking 25% to "invest elsewhere" — you usually lose the tax-shelter without gaining much.
4. Consider age 55-57 vs later. Earlier access gives flexibility; later access gives more compounding.

The "phased flexibility" approach

A common pattern for retiring at 60-65:

• Take a small portion (£10k-£50k) of the 25% to fund early-retirement spending or a bridge to State Pension.
• Leave the rest invested in drawdown.
• Use drawdown income as needed, monitoring tax efficiency annually.
• Keep an eye on the LSA cap if you have multiple pots.

This is more tax-efficient than the "binary" approach of taking 25% all at once.

Income tax considerations on drawdown

Pension drawdown (the 75% taxable part) is treated as employment income:

• Counts toward Personal Allowance (£12,570).
• Above PA, taxed at basic / higher / additional rate.
• Can push you over £50,270 higher-rate threshold even if your pension is your only income.

Worked example — Sarah's first year of drawdown

Sarah (60, £500k SIPP, just took £125k tax-free) draws £30,000/year from the remaining £375,000.

Tax treatment:

• £30,000 drawdown income (taxable).
• Plus State Pension (not yet — she's 60, State Pension Age is 66/67).
• Plus £1,500 of savings interest.
• Plus £2,000 of dividends.

Total taxable income: £33,500.

• PA: £12,570.
• Basic rate (20%) on remainder: £20,930 × 20% = £4,186.
• Total income tax: £4,186.

Plus no NI on pension income or State Pension once over State Pension age.

Inheritance tax — major change coming

A critical change announced in Autumn Budget 2024, effective from April 2027:

Pensions inherited by your beneficiaries will become subject to Inheritance Tax when you die.

Currently (until April 2027):

• Die before age 75: beneficiaries inherit the pot tax-free.
• Die after age 75: beneficiaries pay income tax at their marginal rate as they draw from it.
• Pension pots are excluded from IHT estate.

From April 2027:

• Pension pots are included in your IHT estate for the £325,000 nil-rate band test.
• Beneficiaries still pay income tax on the inherited pension (post-75) or get it tax-free (pre-75) — but IHT is now also charged on the estate.
• This is a significant tax rise for pensioners with sizeable pots and estates over £325k.

Pre-emptive planning before April 2027 may include:

• Drawing down faster from pensions (using up the 25% tax-free portion before inheritance tax catches it).
• Spending pension first, ISA second (reversal of typical advice).
• Gifting strategies during life.

This area is changing quickly — consult a financial adviser if you have a substantial pension pot.

Common mistakes

1. Taking the 25% just because you can — losing tax-shelter for no specific reason.
2. Not considering income tax band when drawing the taxable 75% — staying in basic rate is much better than tipping into higher rate.
3. Forgetting the LSA cap — high earners can over-claim and trigger income tax retrospectively.
4. Treating 25% as "investment capital" — money outside the pension grows taxable.
5. Not coordinating with State Pension start date — drawing pension income before State Pension begins can be more tax-efficient.

Trying the numbers

For modelling drawdown income tax over multiple years:

For overall income picture:

Sources

• HMRC: Tax on your private pension contributions
• HMRC: Tax when you get a pension
• gov.uk: Lifetime Allowance abolition guidance
• Pension Wise: Free pension guidance
• HM Treasury: Autumn Budget 2024 — pension inheritance tax reforms