Pensions tax free cash simplified (again). Sorry!
Peter McGahan
Monday 20th October, 2025.
APRIL 6, 2006 - the day they introduced ‘Pensions simplification day’- My oh my. What a load of twaddle. With nearly 20 years of complisimplification since then, it’s done nothing more than keeping financial advisers in books and a job. I was busy anyway!
Following last week’s column on whether or not to panic into taking tax free cash because of scaremongering budget changes, I thought I would cover the reasonably complicated subject of - just taking your tax-free cash.
The basics: Most people can take up to 25 per cent of the value of their pension as a tax-free lump sum. This is part of the deal we struck with the taxman when we gave up spending today in favour of saving for tomorrow.
Now the science. Sorry.
But - as of April 2024, a new ceiling was introduced. It’s called the Lump Sum Allowance. For most people, that figure is £268,275. It’s a lifetime limit. Not 25 per cent of each pension. Not once per pot. It’s the total amount of tax-free cash you can ever take across all your pensions, full stop.
And yes, there are exceptions. This is simple pensions, after all.
Some people have older protections - primary protection, fixed protection, enhanced protection - which allow a higher limit. Others may have stand-alone lump sum rights or scheme-specific quirks from the pre-2006 world. If you’re one of them, your allowance might be bigger. If you’re not sure, and your pension history includes a greatest-hits tour of past regimes, it’s time to check.
When you take a tax-free lump sum, some types count towards your lifetime cap - and some don’t. The standard 25 per cent you take as a pension commencement lump sum? That counts. So does the tax-free part of what’s known as an ‘uncrystallised funds pension lump sum’. But others, like small‑pot lump sums under £10,000, trivial commutation lump sums, and winding‑up lump sums from defunct schemes, typically don’t eat into your allowance.
Serious ill‑health lump sums don’t reduce your Lump Sum Allowance (LSA), but they do count towards your Lump Sum and Death Benefit Allowance (LSDBA) if you’re under 75 and meet HMRC’s qualifying conditions. (techy huh, sorry?)
And what if you’ve already taken benefits before April 2024? The system hasn’t forgotten. You’ll need to account for what you took under the old lifetime allowance regime.
Here’s where it gets fiddly. If you don’t do anything, your remaining allowance will be reduced by 25 per cent of the lifetime allowance you used. That’s the default. But you can, if you act in time, apply for something called a transitional tax-free amount certificate. This tells HMRC exactly how much tax-free cash you’ve already had - not just a rough proxy. In some cases, this gives you a bigger remaining allowance. But you must apply before taking any more benefits. Wait too long, and the standard calculation locks in.
And if you try to take more than you’re allowed? In a defined contribution scheme, the excess is taxed as income. In a defined benefit scheme, you may receive a pension commencement excess lump sum - catchy name, but not such a friendly tax treatment. Either way, the outcome is the same: a bill.
Defined benefit (DB) pensions have their own flavour of complexity. Often, the scheme lets you swap some income for cash - typically £12 or £15 in cash for every £1 of annual pension given up. But even here, the tax-free cash generated still has to sit within your overall allowance. Some DB schemes offer a separate lump sum as standard - think three-eightieths of final salary per year of service - but again, it has to respect the cap.
And if you’re in one of those hybrid schemes with both DB and DC sections, you might be able to take your full tax-free entitlement from the DC pot, leaving your DB pension untouched. That can be very efficient - but only if your scheme rules allow it, and only if you know the option exists.
First, know your allowance. Second, if you’ve taken benefits before April 2024, get your records in order. You may be better off with a transitional certificate. Third, don’t just grab the cash without checking the implications. Once paid, it’s almost impossible to unwind.
Tax-free cash remains a cornerstone of retirement planning. But the new rules make it less of a free-for-all and more of a tightrope. Walk it carefully, and you can still make it work for you.
Today is pensions complisimplification day. Sorry.
If you have a financial query, please call 01872 222422 and if you would like a complimentary fact sheet on tax free cash planning, please email info@wwfp.net
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
