As you approach the end of your career, it is highly likely that your thoughts will be turning to how you will manage your money in this new stage of life.

One aspect of your savings that you might anticipate using at this stage is your pension tax-free lump sum.

In the 2023/24 tax year, you can typically take 25% of your pension savings tax-free when you reach the normal minimum pension age of 55 (rising to 57 in 2028). 

This money can be invaluable in allowing you to achieve your retirement goals. Whether you want to buy your dream home, travel the world, or retire abroad, being able to access this money can help you to make your ambitions a reality.

Of course, just like any other savings you hold, it is often wise to plan carefully so that you can make the most of your money. This very much includes the tax-free lump sum, yet many over-55s say that they plan to or have already used the entire amount early on.

According to Standard Life, 32% of over-55s have spent or expect to spend their entire lump sum within the first six months of taking it.

While this is not necessarily a bad choice, it highlights the importance of having a plan for your tax-free entitlement. That way, you can be confident that you will be able to make the most of it when you reach the normal minimum pension age.

So, read on to discover three top tips that could help you to manage your 25% tax-free lump sum.

1. Choose how you will take it

Firstly, it is useful to be aware that in the current tax year, you have a choice as to how you take the 25% sum.

You could of course take it all at once in a single withdrawal. This gives you access to a lump sum that you could then use however you see fit, whether that is making one large purchase or using it to fund your lifestyle in the long term. 

Alternatively, you do not have to take it all at once, instead drawing your tax-free sum as a series of small chunks. You could choose to use this to supplement your income, spreading out the tax-free portion of your pension for longer.

You can even draw what is known as an “uncrystallised funds pension lump sum”. This involves multiple withdrawals of which 25% of each is tax-free, with the remaining 75% being subject to Income Tax.

This can allow you to keep your pension savings invested for longer, giving you the potential to generate further returns on your money. However, it is important to note that this may affect your pension allowances in future.

Bear in mind that these options are subject to your pension provider allowing this.

With each strategy having various benefits, you can see why it is important to first consider how you will take your 25% tax-free entitlement.

2. Set out your retirement goals

When deciding how you will take your lump sum, it can often be helpful to consider your goals for the future first. This can make it easier to decide how to effectively use your tax-free money.

For example, if you take your entire lump sum with no plan, you might end up with a significant amount of cash that you then need to save or invest. Without a goal in mind, you might have withdrawn this money and now have no real need for it.

On the other hand, you might start taking smaller amounts of money, only to realise that taking a single lump sum would have been more effective.

Meanwhile, if you work out your retirement goals first, you can make more informed, incisive decisions. 

Imagine that your main targets for retirement are to move to your dream home or help your children onto the property ladder with a gift. In that case, taking your entire lump sum could be the most effective way for you to achieve your ambitions.

Similarly, if your main priority was to draw a retirement income that is as tax-efficient as possible, then taking smaller withdrawals over a longer period could be a more prudent course of action.

Your goals can make a significant difference in determining the right choice for you. That is why it can be helpful to consider them when taking your tax-free sum.

3. Check whether your pension exceeds the Lifetime Allowance

One important aspect to consider, particularly for high net worth individuals, is whether your pension exceeds the Lifetime Allowance (LTA). If so, you may not be able to draw a full 25% of your pension tax-free.

The LTA is the maximum you could save into all your pensions during your lifetime without facing an additional tax charge when you came to withdraw it.

In March 2023, chancellor Jeremy Hunt announced that the LTA charge would be suspended, with plans to scrap the LTA entirely in future. This was done with the goal of encouraging many savers to work longer and maximise their retirement savings.

As a result of this change, you will no longer face an additional charge when withdrawing funds from your pension that exceed the LTA limit. This stands at £1,073,100 in the 2023/24 tax year.

That said, your tax-free lump sum is still limited to 25% of this threshold, or 25% of the value of the pension fund, whichever is lower. Consequently, the maximum sum you can draw from your pension tax-free is £268,275. This figure may be slightly higher if you have a protected LTA.

You will likely be subject to Income Tax if you withdraw more than this from your pension. So, if you have significant pension savings, it may be worth checking whether you exceed this threshold before you take your lump sum.

Get in touch

If you would like to find out more about managing your pension tax-free lump sum, then please do get in touch with us at DBL Asset Management.

Email or call 01625 529 499 to speak to us today.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. 

The Financial Conduct Authority does not regulate tax planning.