5 important factors to consider before taking a tax-free lump sum from your pension

Whether you need to cover essential costs or you’re eager to start living out your retirement dreams early – such as travelling the world or paying for your child’s wedding – it might be tempting to dip into your pension as soon as you become eligible to do so.

If you have a workplace or personal pension, you can usually access these at 55 (rising to 57 in 2028). Moreover, the first 25% of your pensions can be taken tax-free – provided that it does not exceed the Lump Sum Allowance (LSA) which stands at £268,275 in 2025/26. Your LSA might be higher if you previously applied for Lifetime Allowance protection.

Indeed, study by Legal & General (15 January 2025) found that 1 in 5 UK adults who have taken a cash lump sum from their pension pot did so as soon as they turned 55.

However, many do not fully understand the long-term financial consequences of making such a withdrawal – the research revealed that 46% said they took a lump sum, simply “because they could”.

What’s more, 1 in 5 (18%) of those who made such a withdrawal admitted that they would have taken less or no money as a lump sum if they were given the choice again.

So, if you’re thinking about withdrawing a tax-free lump sum from your pension, keep reading to discover five important factors to consider before deciding.

1. Withdrawing a lump sum may affect your future income

If you take a lump sum as soon as you turn 55, there may be less in your pension pot to provide a retirement income when you need it.

Moreover, people often underestimate how long they’ll live, which can lead to a financial shortfall in later life – especially if medical and care costs arise.

According to the Office for National Statistics (ONS) life expectancy calculator (14 February 2025), a male aged 50 will on average live to 84, while a woman aged 50 will live on average to age 87.

So, if you’re a woman who retires at the current State Pension Age of 66 (rising to 67 between 2026 and 2028, and to 68 between 2044 and 2046), you may need to have sufficient savings to cover 21 years. If you retire at 55, your retirement could last more than 30 years.

As such, it’s important to ensure that taking a lump sum from your pension as soon as you become eligible to do so will not put you at risk of running out of money later in life.

2. Leaving your money invested could allow it to grow further

Before accessing your pension, it’s worth asking yourself whether you need the money yet. Just because you can take a tax-free lump sum at 55 (if this is the case), doesn’t mean it’s necessarily the right choice for you.

If you have other sources of income and savings to cover your short- and medium-term costs, it might benefit you to leave your money invested so that it has the potential to continue growing.

Compounding – earning returns on both your original investment and on returns you received previously – can be particularly valuable for pension savers. As such, leaving your money invested and untouched could increase the long-term value of your pension.

Moreover, if you withdraw a lump sum and then leave it sitting in a cash savings account, inflation could erode its purchasing power over time.

3. Taking more than 25% of your pension pot or exceeding the Lump Sum Allowance could have tax implications

Remember that if you take more than the LSA from your pension, you may have to pay Income Tax on any amount that exceeds this threshold if your total earnings exceed the Personal Allowance (£12,570 in 2025/26).

What’s more, if you take your pension as a series of lump sums or start drawing an income from your pension (after taking a tax-free lump sum), you could trigger the Money Purchase Annual Allowance (MPAA).

The MPAA reduces your Annual Allowance – the amount you can pay into a defined contribution pension and still be eligible for tax relief – to £10,000.

In contrast, the standard Annual Allowance is £60,000 for most people, although this may differ if you have a high income or have carried forward unused allowance from previous tax years.

So, if you plan to continue working and contributing to your pension beyond the age of 55, you might want to plan your pension withdrawals with care to avoid triggering the MPAA – which could hamper your progress towards your retirement savings goal.

4. Taking all your tax-free cash upfront limits future flexibility

If you take your tax-free pension lump sum in one go, you may have fewer options for drawing strategically from your pension over time.

On the other hand, you could make smaller tax-free withdrawals as and when you need them, potentially allowing you to sustain a tax-efficient pension income for many years.

This approach could help you to:

• Minimise your Income Tax bill by keeping your overall income within the lower tax bands
• Reduce or avoid paying higher- or additional-rate Income Tax (40% and 45% respectively in 2025/26)
• Plan your finances around other sources of income, such as part-time or consultancy work or your State Pension.

Remember that your retirement could last more than 30 years, so spreading your tax-free pension withdrawals over time could help you avoid a shortfall in later life.

5. You might lose state benefits

You may not be reliant on state benefits currently, but they could provide a valuable income stream during retirement.

So, it’s worth considering the potential impact of taking a pension lump sum on your eligibility for means-tested benefits, such as Council Tax support and housing benefit.

If you’re below State Pension Age, any money you withdraw from your pension will be included in assessments of whether you qualify for certain benefits.

Beyond State Pension Age, the amount you’ve taken as a lump sum and what you have remaining in your pot will be used to calculate your benefits entitlement.

So, withdrawing a lump sum could mean that any benefits you receive or expect to receive, are reduced or stopped.

Get in touch

If you’re considering taking a tax-free lump sum from your pension when you turn 55 – or at any other time – I can help you weigh up the pros and cons so that you can make an informed decision.

To find out more, please get in touch by email at lottie@truefinancialdesign.co.uk or call 03300889138.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate tax planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.  

Workplace pensions are regulated by The Pension Regulator.