When you start taking benefits from your pension, you can usually choose to take a portion of your benefits as a tax-free cash lump sum. Your tax-free amount doesn’t impact on your annual personal allowance, which is – the amount of income you don’t have to pay tax on each year. The personal allowance for the 2021/22 tax year is currently £12,500.
If you have a defined contribution scheme, you can take up to a maximum of 25% of the total amount built up in your pension pot as a tax-free cash lump sum, provided you haven’t not exceeded the lifetime allowance. If you decide to take 25% of your pension as a cash lump sum, your scheme becomes ‘crystallised’ and you then have to decide what to do with the remaining amount.
If you have a defined benefit pension scheme, the scheme’s rules will determine how much you can take as a tax-free cash lump sum, and by how much your subsequent income will be reduced by.
You will have to pay tax on the remaining benefits in your pension. The amount of tax you pay will depend on your total income for the year and your tax rate.
There are a number of pros and cons to deciding to take the cash lump sum and these will depend on your personal circumstances. Be sure to get regulated financial advice regarding your options before making any decision on how and when to take your pension.
Tax treatment depends on your individual circumstances and may change in the future.