What should I do with my pension lump sum?

If you have already retired, or if you are approaching this milestone, you have probably been thinking about what you should do with your pension lump sum. Should you take it now so you can spend or gift it, should you leave it where it is to maximise the potential tax-free return or should you withdraw it in stages to provide a tax efficient income?  

The answer will likely depend on your personal circumstances and your overall retirement objectives. Before you take anything, make sure you understand what type of pension you have, when you can access it, how tax works, and what taking money out now could mean for the rest of your retirement.  

For most people with a defined contribution pension, you can access your lump sum from the age of 55 (rising to 57 from April 2028) and you can normally take up to 25% tax free, subject to the lump sum allowance of £268,275.

What is a defined contribution pension?

A defined contribution (DC) pension is a pension where you build up a pot of money over time through your and your employer's contributions, tax relief from the government, and investment growth. At the point of your retirement, you will not necessarily receive a guaranteed income, but instead, you will have an amount of money you can withdraw and spend flexibly to meet your life expenditure requirements. This means the responsibility is on you to make sure any withdrawals are sustainable so that this money will last for the rest of your life.  

When it comes to how you might use your defined contribution pension, you might take some tax-free cash, leave the rest invested, draw income gradually, or use some or all of it to buy a guaranteed income in the form of an annuity. These decisions can be daunting as you are effectively making decisions that will impact you for the rest of your life, and this is where having a solid financial plan can support the decision-making process.  

What type of pension do I have?

This is the first question to answer before doing anything with your lump sum because your options depend heavily on the pension type you have. And in some cases, you may have a mix of different types of pensions.  

Broadly, most people will have either a defined contribution pension or a defined benefit (DB) pension, which is often called a final salary pension. A defined benefit pension typically pays a secure income for life based on your salary and length of service, rather than giving you a pension pot to manage yourself, providing a level of security not automatically achieved from a defined contribution pension. Defined benefit pensions can come with a decision whether to draw a tax-free lump sum in return for a reduced level of income. This can be an attractive option to pay for a nice retirement holiday, or to give to your children, but again, this decision should be made with the long-term in mind.  

One way to understand the type of pension you hold, is to review the paperwork you have received from your provider. If your statement refers to a projected pot value, fund choices, or investment performance, it is likely a defined contribution pot. If it talks about an annual income payable at a normal retirement age based on service and salary, it is more likely defined benefit. Many people will have more than one pension, and it is not unusual to have a mix. That is why it is worth checking each scheme individually rather than assuming they will all provide a retirement income in the same way.  

When can I take money from my pension?

For private pensions, the earliest age you can usually take money is 55 and this is set to rise to 57 from April 2028. In some cases, you may be able to access benefits earlier because of ill health, but for most savers, the normal minimum pension age applies. Importantly, reaching the age when you can access your pension does not mean you have to take it straight away. Some retirees may benefit from waiting if they do not yet need the money, because leaving the pension untouched can give investments more time to grow and delay the tax decisions that come with withdrawals.  

This is where the real decision starts. If you need cash to clear expensive debt, support your lifestyle, or create a buffer in retirement, taking a lump sum could make sense. If you are still working, still contributing, and do not need the money yet, rushing to take it can be a costly decision. A pension is often one of the most tax efficient places to keep long-term retirement savings, so taking cash just because you can, is not always the best move.  

Am I taxed on my pension?

Usually, yes, at least on part of it. Most people can take up to 25% of their defined contribution pension tax-free, subject to an overall tax free cash lump sum allowance of £268,275. The remaining 75% is usually taxable as income when drawn. That means the amount of tax you pay depends on how much you withdraw in that tax year and what other income you already have. For the 2026/27 tax year, the standard Personal Allowance is £12,570, basic rate tax is charged on the next £37,700, and the higher rate tax applies to the next £74,870 for England, Wales, and Northern Ireland.  

This is why taking your whole pension in one go can result in a nasty surprise. Even if 25% is tax-free, the taxable balance may push you into a higher or additional rate band in that year (or potentially reduce or remove your personal allowance for income over £100,000). Providers also often use a temporary or emergency tax code on the first payment, which can result in too much tax being deducted upfront. In some cases, you can reclaim overpaid tax from HMRC rather than waiting until the end of the tax year.  

How can I take money from my defined contribution pension?

You usually have a few main routes. One option is to take up to 25% tax free and leave the rest invested in a drawdown scheme, which essentially is an investment that you draw an income from, taking taxable income only when you need it. This can suit people who want flexibility and are comfortable with investment risk, but it does mean your money remains exposed to market ups and downs and there is no guarantee it will last for life.  

Another option is to take up to 25% tax free and use the rest to buy an annuity, which gives you a guaranteed income for the rest of your life. This can be attractive if certainty matters more to you than flexibility. The trade-off is that once an annuity is set up, you cannot reverse the decision, and the rate you secure depends on market conditions and your circumstances at the time.  

You can also take your pension as one or more lump sums. In practice, that can mean taking the whole pot in one payment or drawing cash out in stages. This can work well if you want control, but it needs care. Large withdrawals can create unnecessary tax burdens, and once money leaves the pension it loses some of the protection and tax advantages it had while inside the pension account wrapper.  

Can I choose more than one way to take my money?

Yes, and for many people that is where the best answer lies. You do not always have to pick a single option and stick with it. You might take some tax-free cash for short term needs, leave part of the pot invested for later, and use another part to buy guaranteed income. If you have more than one pension pot, you can also use different options for different pensions. That can give you a better balance between flexibility, security, and tax efficiency.  

What if I am still working?  

So far, we have just focused on planning ahead for retirement, but what if you are still working and have a requirement or preference to draw from your pension? In this scenario, just drawing your tax-free cash allowance will not typically restrict the amount that you can contribute to a pension in the future, but taking taxable income flexibly often does. This activates the Money Purchase Annual Allowance, which reduces your annual pension contribution allowance from £60,000 to £10,000, which can matter a great deal if you are still working or may want to keep contributing.  

Another important consideration is HMRC’s ‘Tax-Free Cash Recycling Rules’. These rules say you cannot take a tax-free lump sum from your pension with the intention of paying it back in to gain further tax relief. While this sounds straightforward, it can become more complex in practice and requires careful thought. A common example is where someone plans to draw a tax-free lump sum while they are still working, perhaps to repay their mortgage. Once the mortgage is cleared, they may find they have extra disposable income and decide to increase contributions to their workplace pension.

Although the withdrawal and the increased contributions may appear unrelated, they could still be viewed as linked under the rules. This means the arrangement could breach HMRC guidelines and potentially lead to a significant tax charge.

If you are considering a similar approach, it’s sensible to speak with a financial adviser to ensure you don’t face any unexpected tax consequences.

Speak to a pension specialist today

In most cases, before making any irreversible decisions it is best to pause and look at the bigger picture. Consider what income you will need, what secure income you already have, whether you are still working, how much tax you may pay, and whether taking cash now could reduce your options later. A pension lump sum can be useful, but it should support your retirement plan rather than drive it.

A good pension specialist can help you work through the options and considerations clearly, while helping to guide you through this decision-making process to ensure the action taken is in line with your requirements, not only now, but for the rest of your life. Most importantly, this can help you avoid turning a valuable pension into an avoidable tax bill or a short-term fix that weakens your long-term financial security.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The information is based upon our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.

The value of investments can go down as well as up, you may not get back what you originally invested. The FCA does not regulate tax, estate or cash flow planning.