As you approach retirement, your thoughts may turn to the best ways to use those pension savings you\u2019ve been squirrelling away. And if you\u2019ve got debts to pay, or big purchases you\u2019ve been holding off on, the idea of getting your hands on a chunky pension lump sum may be alluring. <\/p>
The good news is that you should be able to dip into part of your pension pot tax-free. Read on to find out more about the rules around taking a tax-free pension lump sum, and the trade-offs you could be making by doing so.<\/p>
At the age of 55 (rising to 57 from 2028), you can start to take money out of your personal or workplace pensions. Most of the money you take out is subject to income tax, but there\u2019s an exception: the pension tax-free \u201clump sum\u201d. <\/p>
It\u2019s a chunk of your pension that you take out completely tax-free when you reach pension access age (or at any point thereafter) \u2013 25% of your pension value, to be specific. You can use it however you like.<\/p>
Assuming your lump sum doesn\u2019t exceed 25% of the value of your pension pot, you\u2019ll pay nothing, nada, zero, zip. Even if, in the year you take out your pension lump sum, you also have lots of income from employment, your 25% lump sum is exempt from tax. <\/p>
If you decide to take out a bigger lump sum, you\u2019ll be liable for income tax on anything above 25%. How much, if any, income tax you have to pay will depend on how much extra you withdraw from your pension, plus your other taxable income in the same year.<\/p>
Once you\u2019ve used up the tax-free 25% of your pension pot, anything above this will be subject to income tax. The same rules apply to this pension income as to any other income. <\/p>
This means that taxable pension income will be combined with taxable income from other sources, such as employment. You\u2019ll pay tax at the standard UK tax rates. We\u2019ve summarised these in the table below for the 2022\u201323 tax year.<\/p>
Importantly, the first \u00a312,570 of potentially taxable income is covered by your personal allowance, for which the tax rate is 0%. This means that if you earn no other taxable income, you can receive up to \u00a312,570 of pension income per year without paying income tax. That\u2019s in addition to your 25% tax-free lump sum.<\/p>
It\u2019s worth bearing in mind that when you first take money from a pension above the tax-free lump sum, there\u2019s a risk that HMRC might get your tax codes wrong to start with. It\u2019s most likely to happen if the first amount you take out is bigger than you plan to take in subsequent months. This could result in overpaid pension tax<\/a> initially, though you\u2019ll get it back in due course.<\/p>Income tax rates for 2024\/25<\/h4>