Your helpful guide to pension commencement lump sums

Approaching retirement can feel overwhelming, with a multitude of financial decisions to consider.

You might have heard of the “pension commencement lump sum” (PCLS), also known as the “tax-free lump sum,” and wondered how it could affect your retirement income.

You could use this money in a variety of ways, whether you want to travel more, retire abroad, or make other retirement ambitions a reality.

While it may feel like there are many moving parts, the more you understand your options and limitations, the easier your path forward could be.

Here’s what you need to know.

The pension commencement lump sum refers to the amount you can draw from your pension tax-efficiently

You can usually access your pension starting from the normal minimum pension age (NMPA). This currently stands at 55, rising to 57 from 2028. At this stage, you can consider taking a PCLS.

The PCLS refers to the tax-free amount you can withdraw from your defined contribution (DC) pension(s) when you first start taking your retirement benefits. This lump sum could provide a valuable tax advantage, allowing you to receive a portion of your pension savings without incurring an immediate tax liability.

Most private and workplace DC pensions will usually allow you to take a tax-free lump sum of up to 25% of your pot. This might differ if you have Lifetime Allowance (LTA) protection in place.

Your tax-free lump sum is capped by the Lump Sum Allowance (LSA). As of the 2024/2025 tax year, the LSA is £268,275 for those without LTA protection. The LSA applies across all your pensions – you can take up to 25% of each pot tax-free, with the LSA limiting the total amount you can draw before facing a tax charge.

Keep in mind that if you have a defined benefit (DB) or “final salary” pension, the rules may vary. Speak to us if you’re unsure what type of pot you have.

By paying attention to your tax-free lump sum limit, you could reduce your Income Tax bill in retirement

You will have a good deal of flexibility when it comes to using your pension savings, but it’s important to pay attention to the sum you can take tax-free.

There are a few different ways you could handle this, and remember, your Financial Planner can help you outline a specific strategy that works for your unique needs.

2 strategies for maximising your tax-free entitlement

1. Take your entire lump sum in one go

You could take your full 25% lump sum tax-free amount at once and then draw a taxable income from your remaining pension savings.

As with your earnings throughout your career, how much income you withdraw will determine your rate of Income Tax.

Keep in mind that taking large withdrawals could affect the growth of your pension, and all investments can rise and fall in value.

2. Spread your lump sum over multiple withdrawals

With this approach, you could spread your 25% tax-free lump sum over multiple withdrawals and use these sums of cash to achieve personal goals or as part of supplementing a tax-efficient income.

This could give you more flexibility and allow you to manage your tax liability in a way that suits you. You can also then adjust your withdrawal strategy based on your income needs.

Remember, exceeding the tax-free limit could result in you paying Income Tax on your pension withdrawals and affect your overall retirement income.

With Income Tax becoming a greater concern for many pensioners, this is an important consideration to make. In fact, according to PensionsAge, around 3.1 million pensioners (1 in every 5) could be affected by a higher or additional tax rate band by the 2027/2028 tax year.

So, think carefully about your PCLS withdrawal to ensure you’re not depleting your retirement savings faster than necessary, or paying more tax than you need to. Talk to a Financial Planner to fully understand your tax situation in retirement.

Working with your Financial Planner as you approach retirement may help you reduce tax

Your Financial Planner could help you build a tax-efficient retirement plan that considers the PCLS and other factors.

We will take into account your income, tax bracket, and retirement goals to work out the most advantageous way to use your PCLS. From there, we can help you explore options to minimise your tax liability in retirement.

Lastly, by working with a Financial Planner, you can develop a comprehensive plan that optimises your PCLS withdrawal while ensuring you have enough to meet your long-term financial needs.

Tax in retirement can be a tricky subject, and the earlier you start planning, the better. There are plenty of benefits to planning ahead for retirement, and coming up with a strategy for your PCLS is just one aspect of that.

Get in touch

For advice about planning ahead for retirement, maximising your PCLS, and staying ahead of the curve financially, talk to us today. We’re on hand to help you make the most of your money in retirement.

Speak to your existing Planner or email us at enquiries@pen-life.co.uk, or call 01904 661140.

Please note

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

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

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 estate planning or 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.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your circumstances, tax legislation, and regulation, which are subject to change in the future.