The short answer
Take it only if you have a use for the cash that beats keeping it inside the pension wrapper.
Inside the pension, the 25% slice grows tax-free. Once taken, the cash sits in a taxable wrapper (savings account, GIA, ISA only up to £20,000/year). For most people without an immediate need for the lump, leaving the slice inside the pension and drawing it gradually as part of normal income beats taking it on day one. The tax-free lump sum calculator models the exact difference for any pot size.
The four reasons that justify taking it
- Clearing the mortgage or other expensive debt. Saving 5–6% guaranteed mortgage interest in post-tax pounds can beat continued tax-free growth inside the pension at expected investment returns. Use the mortgage calculator for the exact saving.
- Funding a big planned expense. A house purchase, a major home improvement, helping a child onto the housing ladder, paying for a once-in-a-lifetime expense. The lump sum is genuinely free of income tax for these uses.
- Avoiding higher tax in early retirement years. If you're retiring at 60 with no other income for five years before State Pension starts, drawing the lump sum spread across those years uses up the personal allowance more efficiently than waiting and then drawing larger taxable amounts later.
- Taking advantage of an unusually high market. If equities are visibly over-valued at your target retirement date, locking in the 25% slice at the top can reduce sequence-of-returns risk for the remaining 75%.
The four reasons NOT to take it
- You don't have a use for the cash. Once it leaves the pension, it sits in a taxable wrapper. £100,000 in a savings account at 4% generates £4,000 of taxable interest a year — and on a higher-rate taxpayer, that's £1,600 of tax annually that wouldn't have applied inside the pension.
- You're worried about IHT on your estate. Pensions sit outside your estate for IHT purposes (until April 2027 — the position changes from then). Lump sums withdrawn into your bank account are inside the estate immediately. Drawing more than you need accelerates the IHT problem.
- You'd just reinvest it. If the plan is "take it out and put it in an ISA" — you're probably wrong on the maths. The £20,000 annual ISA cap means it would take 5 years to shelter a £100,000 lump, and meanwhile the un-sheltered portion is generating taxable interest or capital gains. Better to leave the lump inside the pension and use the annual ISA allowance from elsewhere.
- You're between £268,275 and the old LTA. The 25% tax-free slice was capped at £268,275 from April 2024. If your pot is £1.2M, you can't take 25% of it tax-free — only £268,275. Taking the lump triggers the cap. Sometimes splitting the access strategically across several pensions or years helps; this is a question for a fee-only IFA.
Worked example — £400,000 pension at 60
Sam, age 60. Total DC pension £400,000. Plans to retire fully at 65, currently working part-time earning £20,000. State pension starts at 67 at about £11,500/year.
- Option A: Take £100,000 lump on day one. Cash sits in 5-year fixed savings at 4%, generating £4,000/year interest, taxable. Pension reduced to £300,000. After 5 years pension at 5% growth = ~£383,000. Sam is now 65, draws the remaining 75% as taxable income across retirement.
- Option B: Take no lump until 65. Pension grows tax-free at 5% over 5 years to ~£510,000. Sam takes 25% of the larger pot at 65 = £127,500 (subject to the £268,275 cap which doesn't bite here). Remaining 75% = £382,500.
Option B leaves Sam with about £25,000 more across retirement, with no offsetting downside. The reason: Option A's cash sits in a less-efficient wrapper for 5 years.
If Sam needs the cash to clear a £100,000 mortgage at 5.5%, Option A wins by saving £30,000+ of mortgage interest over 5 years. The right answer depends entirely on the cash use.
The post-April-2027 IHT change
From 6 April 2027 (under current legislation), defined-contribution pension pots become part of the estate for inheritance tax purposes — a significant change that turns pension wrappers from one of the most IHT-efficient holdings into one of the least. This shifts the calculus on lump sums.
Specifically: if your pension is large enough that the £325,000 nil-rate band plus £175,000 residence nil-rate band won't cover your estate, taking the 25% tax-free lump sum and gifting it under the seven-year rule may save more in IHT than the lump sum costs in lost tax-free growth.
The IHT guide covers the seven-year rule. The gift tracker models the actual saving from a series of gifts. This is genuinely a "fee-only IFA" decision — the variables are individual and the stakes are six-figure.
Common mistakes
- Taking the full lump on day one with no plan. Most common mistake. The cash typically sits in a low-yield savings account for years, generating taxable interest and not being deployed.
- Not knowing about the £268,275 cap. The lifetime allowance regime ended but the LSA (Lump Sum Allowance) replaced it. Pots above £1,073,100 can no longer take a full 25% tax-free.
- Triggering MPAA accidentally. Taking just the tax-free portion ("crystallising" via UFPLS or flexi-access drawdown of the 25%) does not normally trigger the Money Purchase Annual Allowance — but taking any taxable income does, and it permanently caps your future pension contributions at £10,000/year.
- Forgetting that the lump sum is irrevocable. Once it's out, it's out. There's no "putting it back".
Sources
GOV.UK — tax-free pension lump sums · MoneyHelper — taking your pension. UK Tax Drag is educational and not regulated financial advice.