“Don’t give away optionality for no gain.” — A guiding principle we use when helping families make long-term financial decisions.
Introduction
One of the most attractive features of the UK pension system is the ability to take up to 25 % of your pension pot as a tax-free lump sum when you start drawing benefits. For many people, this feels like “free money” — an opportunity to pay off a mortgage, fund renovations, gift to children, or simply build a rainy-day buffer.
But deciding whether to access your full tax-free lump sum immediately is not straightforward. It can have far-reaching implications for:
your retirement income
your tax position
your estate planning
and your future flexibility.
This is a key decision that we help many clients work through carefully. In this article, we’ll explore:
What the 25 % tax-free pension lump sum rule actually means in the UK
The pros and cons of taking it all at once
How upcoming tax and pension rule changes might influence your timing
How it can impact your income strategy and inheritance planning
Practical scenarios that show the trade-offs
Understanding the UK Rules
Before exploring strategy, it’s essential to get the facts straight on what’s currently allowed under UK pension legislation.
How the 25 % rule works
Under current rules, you can normally take up to 25 % of your pension pot tax-free when you “crystallise” your pension — i.e. when you start accessing benefits.
For most people, the maximum tax-free lump sum is £268,275. This figure is known as the Lump Sum Allowance (LSA). If you have certain forms of historic protection (e.g. Enhanced or Fixed Protection), you might be entitled to more.
This rule applies to:
Defined contribution (DC) pensions (e.g. personal pensions, SIPPs, workplace DC schemes)
Some defined benefit (DB) schemes — though calculation and commutation factors can be different.
Important: There is no legal requirement to take this money at all. Some people don’t. Others take part of it gradually. Some take the full amount in one go.
Staged or partial lump sums
You don’t have to take your tax-free lump sum in one go. Many modern pension plans allow partial crystallisation. This means:
You move a portion of your pension into drawdown
You take 25 % of that portion as tax-free cash
You leave the rest invested
You can repeat this in stages over time
For example, if your pot is £400,000, you might crystallise £100,000 this year, take £25,000 tax-free, and leave £300,000 untouched. This can be more tax-efficient and gives you more control over timing and income.
What happens to the remaining 75 %?
The remaining 75 % of your crystallised pot is taxable when you draw it. It’s treated as income and taxed at your marginal rate (20 %, 40 % or 45 % depending on your total income). So the timing of withdrawals matters a great deal.
For example:
Drawing taxable pension while still working may push you into a higher tax band.
Waiting until after you retire, when your income is lower, may mean paying less tax.
The irrevocable nature of the decision
Once you’ve taken your tax-free cash, it can’t be undone. If you withdraw more than you actually need, that cash might sit in a low-interest savings account while the remaining pension pot is smaller — potentially leaving you with less growth and less income later on.
This is why a decision to take the full 25 % shouldn’t be made lightly.
The Pros of Taking the Full Tax-Free Lump Sum
There are perfectly good reasons why some people do take the full amount upfront. Here are the main advantages.
1. Immediate access to capital
You get a significant cash sum, which can be used to:
Repay or reduce your mortgage
Clear other debts
Make home improvements
Support children or grandchildren (e.g. house deposits, weddings, education)
Boost your emergency fund
Many people like the sense of security and control this gives them at the start of retirement.
2. Shielding against future tax or rule changes
We’re entering a period of pension tax reform in the UK. The Government has already legislated for significant inheritance tax changes on pensions from April 2027, and there is speculation around future changes to lump sum rules.
By taking your 25 % now, you lock in today’s allowances. If future governments reduce or cap the tax-free amount, you’ve secured yours in advance.
3. Estate planning flexibility
Money inside your pension is currently outside your estate for inheritance tax (IHT) — but from April 2027, unused pension pots are expected to be brought into the IHT calculation.
If your estate is large, taking the lump sum out now might reduce the portion that is exposed to IHT later. You can also choose to:
Gift some of it (potentially tax-free after 7 years)
Use it strategically in trust or inter-generational planning
4. Psychological benefit
Some retirees feel more comfortable seeing the money in their account. They prefer holding cash rather than leaving it fully invested.
While this isn’t a financial argument, it does matter. Peace of mind is a legitimate factor when designing your retirement strategy.
The Cons of Taking the Full Tax-Free Lump Sum
For many people, taking the full 25 % at once isn’t optimal. There are risks and downsides to weigh carefully.
1. Lost investment growth
Money inside your pension can continue to grow tax-efficiently. If you withdraw a large lump sum and leave it in cash, you lose the power of compounding over what may be a 20–30 year retirement.
For example, taking £100,000 out at 65 could cost you tens of thousands in potential growth by 80.
2. Cash erosion through inflation
A lump sum held in cash loses real value over time if inflation outpaces savings interest rates. Over a long retirement, this can be significant.
Keeping the money invested within the pension may give better inflation protection through diversified investment.
3. Future income insecurity
By withdrawing a large amount, you reduce your pension base, which means:
Less capital to draw income from later
Higher risk of outliving your money
Less flexibility to adjust strategy later in life
Even if you don’t need the income now, leaving money in the pot can provide valuable optionality.
4. Knock-on tax consequences
If you later reinvest the lump sum in other vehicles (e.g. ISAs), the tax efficiency may not be as good as leaving it inside the pension wrapper.
Also, taking taxable withdrawals after the lump sum can trigger the Money Purchase Annual Allowance (MPAA), which limits your ability to make further pension contributions.
5. Timing risk
Market conditions matter. If you take the lump sum during a downturn and leave the rest invested, your drawdown pot may have less time to recover.
Conversely, if you leave more invested and markets recover, your future pot — and income — could be larger.
Key Considerations Before Making a Decision
Every client’s situation is unique. Before taking the lump sum, ask:
Do I actually need the full amount now?
What will I do with it if I take it?
How will this affect my income later in life?
Will it push me into unnecessary IHT exposure or help reduce it?
How might upcoming pension tax changes affect me?
What is my health and longevity outlook?
What other assets and income sources do I have?
This isn’t just a tax question — it’s a lifestyle, cashflow, and legacy question too.
Realistic Scenarios
To make this concrete, let’s consider three typical cases.
Scenario A — Moderate pot, moderate needs
Alice, 64, has a £240,000 SIPP. She wants to retire fully at 66.
She takes £30,000 tax-free (not the full £60,000).
She uses it to clear her mortgage and boost her savings buffer.
She leaves the remaining £210,000 invested, giving her more income flexibility later.
Result: A balanced approach that supports immediate goals without compromising long-term security.
Scenario B — Large pot, estate planning focus
Ben, 68, has a £1.1 million pension and other assets of £800,000. He’s concerned about IHT exposure.
He takes £250,000 tax-free lump sum now (within the LSA limit).
He gifts £100,000 to his children under the 7-year rule and holds £150,000 in ISAs.
He leaves the rest invested.
Result: Reduces the portion of his estate potentially hit by IHT in 2027, while keeping plenty invested for income.
Scenario C — Urgent capital need
Charlotte, 60, needs £80,000 to buy out the mortgage on her home. Her pot is £320,000.
She takes the full £80,000 tax-free lump sum.
The remaining £240,000 goes into drawdown, which she won’t touch for several years.
Result: Sensible for her immediate objective — but it does reduce her investment base. She accepts this trade-off knowingly.
Interaction With Upcoming Inheritance Tax Changes
From April 2027, unused pension pots are expected to be included in the taxable estate for IHT. This is a major change.
Currently, pensions can often pass free of IHT if structured correctly. Under the new rules, larger pots could face 40 % tax on death if your estate exceeds the nil-rate band and residence band thresholds.
This means:
Taking your lump sum now can reduce exposure to that tax
But you’ll need to balance this with the opportunity cost of lost investment growth
Gifting strategies may become more important for high-net-worth families
Giliker Flynn is already working with clients to model “pre-2027 vs post-2027” scenarios.
Tax Timing: A Subtle but Crucial Factor
Even though the 25 % is tax-free, what you do next matters.
If you draw the rest of your pension soon after, you might face a large income tax bill. But if you leave it, you might reduce tax exposure in retirement.
Common strategies include:
Staggering withdrawals over multiple tax years
Aligning lump sum withdrawals with retirement dates to avoid higher tax bands
Keeping the lump sum invested outside the pension (e.g. in ISAs) for tax-free growth
Our View: A Balanced Approach
At Giliker Flynn, we rarely recommend taking the full 25 % tax-free lump sum by default. For most people, the best outcomes come from:
Taking only what you actually need
Phasing withdrawals to manage tax and investment growth
Coordinating pension decisions with estate planning
Stress-testing different market, tax, and longevity scenarios
For some, taking it all now makes sense. For many, taking part and leaving part is smarter.
When It Might Make Sense to Take It All
You have a clear, valuable use for the cash (e.g. debt repayment, house purchase)
You have a large estate and want to reduce future IHT exposure
You have health issues and a shorter expected lifespan
You’re worried about rule changes and want to lock in allowances
When It Might Not Be Wise
You don’t actually need the money yet
You’d end up parking it in a low-interest account
You’d lose tax efficiency and investment growth
It would undermine your future income flexibility
Practical Next Steps
Model your income needs — how much do you actually require in the first 5–10 years of retirement?
Assess your estate and IHT exposure — especially with 2027 changes coming.
Coordinate with your spouse or partner — joint pension planning can offer more flexibility.
Use regulated financial advice — pension withdrawal is a regulated activity, and mistakes are expensive.
Keep the plan under review — what makes sense today might change in two years.
Final Thoughts
The 25 % tax-free lump sum is one of the most valuable features of the UK pension system. But it’s not a “use it or lose it” decision — nor should it be taken lightly.
For most people, a measured, phased approach makes more sense than an all-or-nothing move. For others — particularly those with estate planning priorities or immediate capital needs — taking the full lump sum can be smart.
As a family-run financial planning firm, we focus on real-life outcomes, not just numbers. That means understanding your goals, your family, your risks, and the rules — then tailoring a strategy that works for you.
Important: Tax and pension rules can change, and their value depends on your circumstances. Always seek regulated financial advice before making decisions.
If you’d like Giliker Flynn to build a personalised “Take Some or Take All?” pension scenario for your retirement, get in touch. We can model tax, income, estate and market impacts so your decision is informed, not rushed.