Can I Take 25 Percent of My Pension Tax Free Every Year

Can I Take 25 Percent of My Pension Tax Free Every Year?

In the UK, one of the key benefits of saving into a defined contribution pension is the ability to take up to 25 percent of your pension pot tax free once you reach the minimum pension age. This can be a valuable way to access funds while reducing your income tax liability. However, many people wonder whether they can take 25 percent of their pension tax free each year or if this is a one-off benefit.

This article explains how the tax-free pension lump sum works, what options are available, and how to use your pension tax efficiently in retirement.

What is the 25 percent tax-free lump sum?

From age 55 (rising to 57 from April 2028), you can begin accessing your defined contribution pension, such as a personal pension, workplace pension or self-invested personal pension (SIPP).

The government allows you to take up to 25 percent of your pension pot tax free. The remaining 75 percent is usually taxed as income when you withdraw it.

This tax-free portion is often referred to as your pension commencement lump sum.

Can you take 25 percent tax free every year?

No, you cannot take 25 percent of your entire pension pot tax free every year on an ongoing basis. The tax-free amount is limited to 25 percent of the total value of your pension pot, not 25 percent of each individual withdrawal unless you are using a specific method of accessing your pension.

There are two main ways you can access your pension in a tax efficient way:

1. Take the 25 percent lump sum all at once

This is the traditional approach where you withdraw 25 percent of your total pension pot as a single, tax-free lump sum. You can then either:

• Leave the rest of your pension invested and draw income over time

• Use the remaining 75 percent to buy an annuity or enter drawdown

• Take further withdrawals which are subject to income tax

Once you have used up your 25 percent allowance, any further withdrawals are taxed.

2. Use UFPLS (Uncrystallised Funds Pension Lump Sums)

This method allows you to withdraw money from your pension in smaller chunks. Each time you take money out:

• 25 percent of that withdrawal is tax free

• 75 percent is taxed as income

This means if you choose to take out £10,000 in a year, £2,500 would be tax free and £7,500 would be taxed.

With this method, you can take 25 percent of each withdrawal tax free, but not 25 percent of your entire pot every year indefinitely. The total tax-free amount is still capped at 25 percent of your total pension pot.

How many times can you take tax-free withdrawals?

You can take as many withdrawals as you like, but once you have withdrawn 25 percent of your total pension pot tax free, you cannot claim more tax-free amounts from the same pot.

For example:

• Your pension pot is £100,000

• You withdraw £25,000 tax free

• The remaining £75,000 will be taxed as income when withdrawn

Alternatively:

• You withdraw £10,000 per year using UFPLS

• For the first four withdrawals, £2,500 is tax free each time

• After four years, you will have used your full 25 percent allowance

After that, all future withdrawals will be fully taxable at your income tax rate.

What about drawdown pensions?

If you use flexi-access drawdown, you can take the 25 percent tax-free lump sum when you first move funds into drawdown. You do not have to take it all at once, and you can move funds into drawdown in stages, each time releasing 25 percent of the amount as tax free.

This method allows some flexibility in how you access the tax-free portion, but again the total tax-free entitlement is limited to 25 percent of your overall pot.

Important considerations

• Once you start taking pension income, you may trigger the Money Purchase Annual Allowance, which limits further pension contributions to £10,000 per year

• Large withdrawals can push you into a higher income tax bracket

• Leaving more money in your pension can help it grow tax free and may have inheritance tax advantages

• Tax rules can change, so it is a good idea to get financial advice before making any decisions

Final thoughts

You cannot take 25 percent of your pension tax free every year without limit. Instead, you are entitled to a one-off tax-free amount worth 25 percent of your total pension pot. You can access this all at once or gradually through smaller withdrawals where 25 percent of each is tax free, but the total tax-free amount remains capped.

Understanding how your pension withdrawals are taxed is key to managing your retirement income efficiently. Speak to a financial adviser or use free services like Pension Wise to plan your withdrawals in a way that suits your needs and minimises tax.