Pension Tax-Free Lump Sum: How the 25% Rule Works (2026/27)

The pension tax free lump sum is one of the most generous reliefs in the UK tax system: when you start taking money from a defined contribution pension, you can normally take 25% of it completely free of tax. That 25% sits at the heart of almost every retirement plan, yet it is widely misunderstood. This guide explains exactly how the rule works in the 2026/27 tax year, how much you can take, how the rest is taxed, and the costly traps to avoid.

What is the 25% tax-free lump sum?

When you access a defined contribution pension (sometimes called a money-purchase or pot-of-money pension), HMRC lets you take a quarter of it without paying any income tax. In the rules this is called your pension commencement lump sum, but most people just call it tax free cash or the 25% tax free pension entitlement.

The remaining 75% is not tax-free. It is taxed as ordinary income in the year you withdraw it, at whatever income tax rate applies to you once it is added to your other income for that year. So the headline is simple: one quarter tax-free, three quarters taxable as income.

This applies to defined contribution pensions: personal pensions, SIPPs, stakeholder pensions, and most modern workplace schemes. Defined benefit (final salary) pensions work differently. They usually pay a guaranteed annual income, and you can often exchange ("commute") part of that income for a tax-free lump sum, but the calculation is set by the scheme, not by a straight 25% of a pot.

When can I take my pension?

One of the most common questions is simply when can I take my pension. For most people the answer is the normal minimum pension age, which is currently 55. This is rising to 57 from 6 April 2028, so anyone born after 5 April 1973 will generally need to wait until 57.

• You can usually access tax free cash from age 55 (57 from April 2028).
• You don't have to take it all at once, and you don't have to stop working.
• Taking your pension earlier than this is only possible in narrow cases, such as serious ill health, and unauthorised early access can trigger punishing tax charges.

Being allowed to take it from 55 does not mean you should. The age is a permission, not a recommendation.

The £268,275 cap explained

The 25% is not unlimited. There is a lifetime ceiling on the total tax-free cash you can take across all your pensions, known as the lump sum allowance. For 2026/27 this is frozen at £268,275.

That figure is exactly 25% of the old £1,073,100 lifetime allowance, which is why it looks so oddly specific. In practice:

• If your total pension savings are below about £1,073,100, the 25% rule is what limits you, and the £268,275 cap never bites.
• If your pensions are larger than that, your tax-free cash is capped at £268,275, even though 25% of the pot would be more.
• The cap is a lifetime pension lump sum allowance across all your schemes combined, not a per-pension limit.

A small number of people hold protected allowances from previous regimes and may be entitled to more, but for the vast majority £268,275 is the hard ceiling.

How is the other 75% taxed?

The taxable 75% is added to the rest of your income for the tax year and taxed under the normal income tax bands. For England, Wales and Northern Ireland in 2026/27 those bands are:

(Scotland sets its own income tax bands, so a Scottish taxpayer's bill on the taxable 75% will differ.) The key insight is that drawing a large taxable amount in a single year can push you into a higher band, so spreading withdrawals across tax years often saves tax.

Two ways to take your tax-free cash

You don't have to take all your 25% in one go. There are broadly two approaches:

1. Take the full 25% at once. You crystallise the whole pot, take a quarter tax-free, and move the remaining 75% into drawdown or buy an annuity with it. Simple, but it locks in your tax-free amount immediately.
2. Take it gradually (UFPLS or phased drawdown). Each time you withdraw, 25% of that slice is tax-free and 75% is taxable. This lets you leave more invested and control which tax year the taxable income lands in.

The right choice depends on your wider income, your other savings, and how long the money needs to last. The Pension Drawdown Calculator can help you model an income that lasts, and the Pension Lump Sum Tax Calculator shows the tax on a single withdrawal.

Worked example: a £200,000 pension pot

Meet Priya, 60, with a £200,000 SIPP and no other income this tax year. She decides to take her full tax-free cash and then draw some taxable income.

• Tax-free lump sum: 25% of £200,000 = £50,000, paid completely tax-free. This is well under the £268,275 cap, so the cap is irrelevant here.
• Remaining pot: £150,000 moves into drawdown, where it stays invested.

Suppose Priya then draws £20,000 of taxable income from the drawdown pot in the same year. Because she has no other income, her tax works out as:

So Priya receives £50,000 tax-free plus £18,514 net from her £20,000 taxable withdrawal: £68,514 in her pocket, and £130,000 still invested for the future. By keeping her annual taxable draw inside the basic-rate band, she avoids 40% tax entirely.

Contrast that with taking the whole £150,000 taxable amount in one year. That would push a large chunk into the 40% higher-rate band (and start eroding her Personal Allowance above £100,000), creating a tax bill of tens of thousands of pounds. Same pot, very different outcome, purely because of timing.

Common mistakes

• The emergency-tax trap. The first time you take a taxable lump sum, your pension provider often applies an emergency "month 1" tax code. This can over-tax you heavily because HMRC's system assumes you'll take that amount every month. You usually get the overpayment back, but you may have to reclaim it using forms P55, P53Z or P50Z, or wait for HMRC to reconcile it. Plan for the cash-flow gap.
• Taking it just because you can. Reaching 55 (or 57) doesn't mean you should withdraw cash you don't need. Money left in a pension grows largely tax-free and is normally outside your estate for inheritance tax. Pulling out a big lump sum to sit in a low-interest account can cost you growth and tax efficiency.
• Crystallising the whole pot too early. Take the full 25% in one go and you've used up all your tax-free entitlement on that pension. Phasing it can keep future growth partly shielded.
• Triggering the Money Purchase Annual Allowance (MPAA). Once you take taxable income flexibly, the amount you can keep contributing to pensions with tax relief usually drops sharply (to £10,000 a year). Taking tax-free cash alone does not trigger it, but taking taxable income does, this matters if you're still working and saving.
• Forgetting the lump sum allowance. With several pensions, it's easy to lose track of how much tax-free cash you've already taken against the £268,275 ceiling.

Where to go next

If you're new to all this, start with our beginner's guide to how pensions work, then read pension tax relief explained to understand the tax breaks on the way in. You'll find more in the pensions guides, and you can crunch your own numbers with the Pension Lump Sum Tax Calculator.

FAQs

Is the 25% always tax-free?

Yes, for the portion within your lump sum allowance of £268,275. Once you've taken £268,275 of tax-free cash in total across all your pensions, any further withdrawals are taxed as income, even if 25% of the pot would be more.

Do I have to take the whole 25% at once?

No. You can take it gradually. With phased drawdown or UFPLS, 25% of each withdrawal is tax-free and 75% is taxable, which lets you leave more invested and manage your tax year by year.

Can I take my tax-free cash and keep working?

Yes. There's no requirement to retire to access your pension from age 55 (57 from April 2028). But remember the taxable part stacks on top of your salary, which could push it into a higher tax band.

What happens if I'm over-taxed on my first withdrawal?

You can reclaim it. If you've been put on an emergency tax code, use HMRC form P55, P53Z or P50Z depending on your situation, or HMRC will eventually reconcile it automatically. You shouldn't be left permanently out of pocket.

Does taking tax-free cash affect how much I can pay into a pension?

Taking only the tax-free lump sum does not trigger the Money Purchase Annual Allowance. But taking taxable income flexibly usually does, reducing your annual pension contribution limit to £10,000.

Sources

• gov.uk - Tax when you get a pension
• gov.uk - How you can take your pension
• MoneyHelper - Tax when you take money from your pension

This guide is general information, not personal financial advice. For your own circumstances, speak to a qualified adviser.