Pension Lump Sum – A Complete Guide

If you’re planning your retirement, you might have heard of the pension freedoms that allow you to access a tax-free lump sum from your pension at 55. But did you know, taking a pension lump sum, is just one of the ways that you can now access your pension: 

You now have many options available to you at 55:

  • Leave your pension invested if you don’t need to take money straight away
  • Take the tax-free cash and leave the rest invested
  • Take some or all of the money as a cash lump sum
  • Buy an annuity to provide a lifetime’s secure income
  • Use a combination of the above

If you’re considering taking a pension lump sum, it’s worth understanding how they work, what the rules are and whether it’s in your best interest to do so. We’ve answered some of the questions we get asked most frequently below, but if you have any other questions, please get in touch and we’ll be happy to help.


What is a Pension Lump Sum? 

A Pension lump sum is a lump sum amount taken from your pension. How and when you can take it depends on the type of pension scheme you have. 

Taking a pension lump sum from a Defined Contribution pension

If you have any sort of pension where you build up a pension pot that you will use to provide you with an income in retirement – it’s known as a Defined Contribution Pension.

Personal pensions, SIPPs and standard workplace pensions are all types of Defined Contribution Pensions. If you have a Defined Contribution Pension you will normally be able to access a cash lump sum from your pension from the age of 55.

  • Taking a pension lump sum from a Defined Benefit/Final Salary pension

Defined benefit schemes guarantee to pay you a set amount every year in retirement (normally adjusted for inflation every year).

Some defined benefit pension schemes automatically offer it’s members a cash lump sum in addition to the pension you’ve built up, which you’ll normally get this when you retire.  

In other defined benefit schemes you may be able to exchange some of the pension you’ve built up for a cash lump sum (known as commutation – see how it works here), so you get a smaller pension paid out every year but, you get a lump sum up front, again this normally happens when you retire.

  • Pension Lump Sum – Defined Contribution vs Defined Benefit 

Most of the flexibility to access lump sums from your pension applies exclusively to those with a defined contribution pension (also known as a money purchase pension). If you have a defined benefit/final salary pension, you’ll need to check with your pension trustees for the rules that apply to your scheme. Find out how the pension rules affect Final Salary Pensions.

Can I take my pension as a lump sum?

With the introduction of Pension Freedoms in 2015. You can now take your entire pension pot in one go once you reach 55. That said, there are a number of things you should consider before you do so, and you should definitely seek professional advice first

Things to consider: 

  • How much tax you’ll pay
  • Will it affect you being able to continue to pay into your pension?
  • How will you fund your retirement?
  • Will it affect inheritance tax for your loved ones if you die?

Should I take a lump sum from my pension?

If you up to take a lump sum from your defined contribution pension. it will reduce the amount you have invested in your pension pot, so there’s less money in your investments and you will have less to last you through retirement. 

If you don’t have an immediate need for the money you may be better off leaving it invested in your pension. If you opt to take your pension lump sum and leave it in cash or put it in a standard savings account,  your money will likely be eroded by inflation. Talk to your financial advisor about ring-fencing money in a low-risk investment if you’re worried about risk.

Another thing you should be aware of especially if you’re concerned about inheritance tax is that pensions sit outside your estate and therefore aren’t subject to inheritance tax like the rest of your assets. Any money you take out of your pension immediately becomes part of your estate and liable for inheritance tax at 40%.

Learn more about Inheritance Tax Rules 

How much tax will I pay?

The first 25% of your pension is tax-free after that you’ll pay tax at your highest marginal rate.

However, you may end up paying emergency tax in which case you will need to reclaim the overpaid tax directly from HMRC. You may also find that your full tax allowance is not yet available especially if you opt to take your lump sum at the start of the tax year, again if you overpay tax you can reclaim it.

Your pension trustees will usually work with the tax code that HMRC give them. Unfortunately, it’s not uncommon for this to be incorrect and you could over or underpay tax in the early months of taking a regular income from your pension. The good news is that HMRC is normally pretty good at sorting out any issues if you call them.  

You can find out how much tax you’re likely to pay on your lump sum using these Pension lump sum tax calculators 

5 of the best pension lump sum tax calculators

Is a pension lump sum classed as income?

The first 25% you take from your pension is tax-free but anything after that is classed as income. How you’ll be taxed depends on how you opt to take your pension lump sum – there are a number of ways that you can do so:

Take cash in chunks 

With the pension freedoms of 2015, if you have a defined contribution pension, you can now take your pension as a series of cash lump sums the first 25% will be tax-free with the rest taxed at your marginal rate.

take cash in chunks from your pension

You can start taking chunks of cash from your pension pot from the age of 55. you may even use lump sums from your pension to fund early retirement or use the money to subsidize phased or semi-retirement. This is also achievable through flexi-access drawdown, which allows you to take as much or as little from your pension as you need. 

If your pension is invested, it’s worth remembering that the value of your remaining pension pot can go down as well as up, so the amount available to you in the future could change.

Take your whole pot as a lump sum – example

You can also opt to take your entire pension pot as one cash lump sum. 25% will be tax-free, but the rest of your pension pot will be taxed at your marginal rate of tax. Depending on the size of your pension pot and how much you have already earned in the tax year – this could push you into a higher tax bracket.

taking your whole pot in one go pension lump sum

Taking your Tax-free Lump Sum – example

You can take your entire tax-free lump sum – 25% of your pension pot in one go, leaving the remaining 75% invested for your retirement. 

taking tax free cash only cash lump sum

It might be tempting to take all of your tax-free cash at 55, especially if you want to clear down debts, pay off a mortgage or buy an investment property, but you should carefully consider the impact of doing so on the size of your pension pot and whether it will leave you enough money for retirement. 

You don’t have to take all of your tax-free cash in one go, you could take some now, and leave the rest invested to take later.

Can I take 25% of my pension tax-free every year?

You will only ever get to take 25% of the total value of your pension as tax-free cash. It is not an annual allowance.

If you access your pension pot at a series of lump sums known as FLUMPS or UFPLS then the first 25% of any chunk you take will be tax-free, the remaining 75% will be taxable at your marginal rate. If you take your money this way you can access 25% of your pension tax-free every year but it will only be 25% of the lump sum you take. 

How do I take my tax-free cash from my pension?

If you want to access a lump sum from your pension, you’ll need to contact your pension scheme directly.

If you want to access your pension flexibly through Pension drawdown, 

  1. Find out if your current scheme offers a flexible access drawdown option, some older schemes don’t. If your scheme doesn’t offer pension drawdown then you’ll need to transfer your pension to a scheme that does.
  2. If your pension scheme allows Pension drawdown then you’ll be asked to fill in some forms and provide proof of identity before any money is paid to you.

How long does it take to get my Pension Lump Sum

Pensions are not like bank accounts, it can take a bit longer for pension trustees to process requests for lump sum amounts. It’s not unusual for it to take 2 weeks or more for your pension company to get your money paid out to you. 

If it’s the first time you’re requesting money from your pension it could take even longer. Pension trustees aren’t known for their lightning-fast customer service, so plan ahead and leave plenty of time until you need the money. 

How many pensions can you cash in?

If you have a number of small pensions you may be able to take them as cash lump sums under the trivial lump sum rules as long as you are 55 or meet the criteria for ill-health early retirement. You can take up to 3 non-occupational pensions up to the value of £10,000 each and an unlimited number of occupational pensions worth up to £30,000.

It’s worth noting that the same tax-rules apply. The first 25% is tax-free, anything after that, you’ll pay tax on it.

Can I take Pension Lump Sum at 55?

Changes to the pension rules in 2015 mean that you now have much more choice about how you access your pension at 55. If you have defined contribution pension you can access it from 55.

At 55 you can: 

  • Keep your pension invested and continue to pay into it and receive tax-relief until you are 75
  • Access 25% of your pension pot as tax-free cash and leave the rest invested
  • Take your entire pension pot as a cash lump sum
  • Take just part of your pension pot as a cash lump sum
  • Use some or all of your pension pot to buy an annuity to provide a lifetime’s secure income
  • Use a combination of the above

Pension lump sum and the Money Purchase Annual Allowance 

It’s worth noting that as soon as you start taking an income from your pension you’ll trigger the Money Purchase Annual Allowance, which drastically reduces the amount that you can pay into your Money Purchase Pension (also known as a Defined Contribution Pension).

Things that will trigger the MPAA:

  • Taking your whole pension pot as a lump sum or taking ad-hoc lump sums 
  • Going into a flexi-access drawdown scheme and taking an income
  • Buying an investment-linked or flexible annuity where your income could go down
  • Taking payments that exceed the cap on a pre-2015 capped drawdown plan

Read more about the Money Purchase Annual Allowance here

Final Salary Pension Lump Sum

The rules around Final Salary Pensions (Defined Benefit Pensions) are a bit different. Your scheme trustees set the rules about when and how much cash you can access from your pension as a lump sum. So you’ll need to check with your pension scheme directly.

You might automatically be offered a cash lump sum as well as your pension, this is normally true if you’re in a public sector defined benefit scheme. Usually, the lump sum is paid when you start taking your pension.

If you don’t automatically get a cash lump sum from your pension, it may be possible to swap some of your future pension for a lump sum now.  This is called commutation and the amount you will have to swap is known as the commutation factor, which is decided by your pension scheme administrators. 

It’s worth getting advice from a pension specialist if you’re trying to decide whether or not to take your pension early, or whether you should commute your benefits to get a cash lump sum. It can be hard to understand the true value of the benefits you might be giving up – getting the right advice now could save you £££s in the future.

Need advice about your Pension Lump Sum?

If you need advice on how and whether to take your tax-free lump sum, or if you need help moving your pension into a suitable drawdown scheme we’d be happy to help. Schedule a free call with one of our Independent Pension Advisers today. You might also be interested in our new pension drawdown calculator (click here).

Simon Garber, DIP PFS | Pension Transfer Specialist | Southampton

About the Author

Simon Garber DIP PFS is an Independent Financial Advisor and Qualified Pension Transfer Specialist. He is the Managing Director and Founder of 2020 Financial, based in Southampton, Hampshire. Simon specialises in Pensions and Retirement planning and is a later life planning specialist. He also holds qualifications in investment and life insurance and is a member of the Personal Finance Society and Chartered Insurance Institute.

Simon is passionate about providing the highest standards of customer care and transparency. 2020 Financial were awarded the Pension Gold Standard in 2019. You can find out more about Simon here.

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