What’s the best way to take your tax-free pension cash?
Financial Interest was founded by Damien Talks Money (407,000 YouTube subscribers) to teach the personal finance lessons he wished he'd been taught at school.
Last updated 30th June 2026
10 min read
Few things in life feel quite as satisfying as getting a chunk of money without handing a penny of it to HMRC.
And for UK defined contribution pension holders, that's the deal – you can take 25% of your pension pot without paying any tax, up to a maximum of £268,275.
There are a few different ways to get your hands on it:
- Take your whole tax-free portion now. Most pensions let you take 25% of your pot without paying any tax. Your tax-free portion gets "crystallised", and the remaining 75% stays invested and is taxed as income as you withdraw it through flexi-access drawdown.
- Take your tax-free portion in chunks. Rather than taking all your tax-free cash at once, you can take it in instalments over time. You could also mix each tax-free withdrawal with taxable chunks.
- Take a series of partially tax-free lump sums from your whole pot. Each withdrawal is automatically 25% tax-free and 75% taxable – so the tax-free portion drips out gradually. This is known as UFPLS, because the pensions industry loves a horrible acronym.
But if you're mystified by these options, you're not alone. In fact, 43% of over-55s are unaware that taking tax-free cash is even a possibility.
The good news is that the right approach usually becomes much clearer once you ask yourself a few simple questions, which we'll run through below.
If you've got a Defined Benefit pension (common for public sector workers), this guide won't apply to you. However, you should check out our full rundown on how these types of pensions work over on our YouTube channel or request our DB pension decoder.
Financial Interest provides guidance, not advice. If you’re unsure about anything, speak with a qualified adviser. When investing, your capital is always at risk. Past performance does not guarantee future results.
Do you plan to continue working?
Or more specifically: are you still paying into a pension?
If you are, this is when you might stumble across another unpleasant acronym: the Money Purchase Annual Allowance, or MPAA.
This is a rule that reduces your annual pension contribution allowance to £10,000, rather than the regular £60,000 – including tax relief and employer contributions.
This rule kicks in – permanently – as soon as you start withdrawing taxable income from your pension. This means that UFPLS* would trigger the MPAA*, as every portion of a withdrawal is taxable, whereas taking your 25% tax-free lump sum – or several tax-free lump sums – would not.
*Apologies for all the acronyms. If you re-read what we've covered so far, this should make more sense.
Annoying as it may be, this rule exists as part of wider "pension recycling" rules to stop people from withdrawing pension money and then immediately paying it back in to claim tax relief on it all over again.
So if you do plan to continue working, and your total pension contributions are likely to be more than £10,000, your only options are to either wait, or to take all (or part) of your tax-free lump sum. Avoid UFPLS.
Do you have any other sources of income?
There's another snag to taking that tax-free cash if you do continue working or have money coming in from elsewhere.
Your salary, the State Pension, and money from things like renting out property all count towards your total taxable income. And once you've taken your tax-free portion, the remainder will be taxed at your regular marginal income tax rate.
This means that even if you take a portion from your drawdown pot that's below your £12,570 tax-free allowance, anything additional you earn on top could still push it into taxable territory.
For example, say you take £10,000 from your drawdown pot in a year when you're also earning £8,000 from part-time work. Combined with your £8,000 salary, your total income is £18,000, meaning £5,430 of your withdrawal is now taxable, landing you with a bill of around £1,086.
One solution would be taking a smaller chunk of your tax-free allowance.
Tax rules are subject to change and these figures are just for example purposes.
Another would be using UFPLS, where 25% of each chunk is tax-free – that would mean exceeding your personal allowance by just £2,930, dropping your total tax bill to £586.
How pension income is taxed
Outside of your tax-free lump sum, pension income is taxed just like regular income. For the 2026/27 tax year, that's:
Up to £12,570: no tax (your personal allowance)
£12,571 to £50,270: 20% basic rate
£50,271 to £125,140: 40% higher rate
Above £125,140: 45% additional rate.
Tax is applied to your total income, meaning anything extra you get from the State Pension, rental income or work. This means that any taxable withdrawals you make can push you into higher tax bands, even if they're small amounts on their own.
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Do you have a plan for the money?
Taking your entire tax-free lump sum all at once can be seriously tempting, especially when you've spent decades working hard for it.
If you don't have something specific you need the money for, though, this can be one of the least tax-efficient moves you can make.
This is because while the money's in your pension, it can grow free from tax. Once it's released from that wrapper, not only will it stop growing unless you invest it elsewhere, but the taxman can also get his greedy mitts on it in ways you might not anticipate.
Let's walk through a few scenarios.
The average pension pot for people aged 55-74 is £140,000. 25% of that is £35,000 – an awful lot to find a good home for.
- Should you put the money in a savings account? This is what most people do, according to research from Interactive Investor. But if you're a basic-rate taxpayer, you can only accrue £1,000 of interest per year without having to pay tax. At 4% interest, after one year, £400 of your cash would be taxable
- How about an ISA? Great idea, but the annual ISA allowance is £20,000 – which leaves £15,000 you still need to find some other home for
- Maybe you should stick it in a General Investment Account? There's no limit here – but you will be exposed to both dividend and Capital Gains Tax.
All seemingly decent options – but all taxable.
And because you’ve already used up your tax-free allowance, once that money's gone, every extra pound you withdraw is potentially taxable – potentially nudging you into higher tax bands and giving HMRC an increasingly generous cut of your retirement.
That doesn't mean taking the lump sum upfront is automatically a bad move.
You might use it to wipe out your mortgage or clear expensive debt. If your rate is higher than the return you'd reasonably expect from investing, that can make perfect sense. The same can apply if you're gradually moving money into ISAs over several tax years, where future growth and withdrawals can remain tax-free.
Or maybe you simply want to enjoy the money. Help your kids onto the property ladder. Buy the campervan. Take the once-in-a-lifetime trip while your knees still work properly.
But taking it without a solid justification is almost always a poor decision.
Looking for help? Try speaking with Most who can put you in touch with a financial adviser.
Do you need to bridge a gap before the State Pension?
One of the nicer retirement problems to have is figuring out how to fund the gap between finishing work and your State Pension arriving.
If this is you, it's worth giving careful consideration to how much of your tax-free cash you access and when.
Let's compare all three options in turn, and see what saves you the most money in the long-run.
This time, we’ll assume your pension pot is £360,000 making your tax-free portion £90,000.
Strap in, because it's about to get a little bit complicated.
Option one: take the whole amount in one go
With this option, you naturally pay no tax now on your whole £90,000. As we've seen though, you have to find a (potentially taxable) home for it all.
Anything else you withdraw from your pot will also be taxable.
So, when your State Pension kicks in, assuming you’re withdrawing around £10,800 per year from your remaining pot (in line with the 4% rule), your total income for the year would then be around £23,347.
Under current tax thresholds, £10,777 of your money would be taxable – an annual bill of £2,155. Ouch.
Option two: take a series of tax-free instalments
In this scenario, you take your tax-free cash as a series of lump sums – £15,000 a year for six years.
While this might help curb your spending urges, it does nothing for your eventual tax liability when your State Pension kicks in.
Once you start withdrawing the taxable £10,800 a year from your pot, you'll still be left with the same £2,155 annual tax bill, because you've still used up your entire tax-free pot.
Option three: take a series of partially tax-free instalments
Taking taxable instalments definitely sounds worse, doesn't it? But in this example, it's actually much better.
We'll assume you're using UFPLS. So, each chunk is 25% tax-free, 75% taxable.
When you withdraw your £15,000 per year up to State Pension age, the taxable portion is still under your personal allowance – so once again, no tax to pay there.
After State Pension age, we'll assume you withdraw the same £10,800 from your pension using UFPLS to supplement your income.
Because each £10,800 withdrawal is 25% tax-free, only £8,100 of it counts as taxable income. Combined with your £12,547 State Pension, your total taxable income is £20,647 – meaning just £8,077 exceeds your personal allowance, and your annual tax bill is £1,615 rather than £2,155.
That's a saving of £540 a year. And because you've preserved so much of your tax-free entitlement, you'd keep making that saving for around 25 years, until you reach age 91. Over that period, the total tax saved compared to taking your lump sum upfront would be around £13,500.
You don't necessarily have to use UFPLS to achieve this – you could get the same result through flexi-access drawdown, by crystallising your pot in stages and taking the 25% tax-free portion each time, rather than all at once. The tax outcome is the same, it's really just a question of which method you find simpler to manage.
Another way to bridge an income gap would be to withdraw from your ISA, if you have one, where all withdrawals would be completely tax-free.
That means if you've already taken enough from your pension to use up your personal allowance, you could draw from your ISA for any extra income you need without triggering a tax bill.
Which options does your provider allow?
Finally, before you settle on any option, it's important to check whether it's actually available to you.
Although most workplace pensions are pretty flexible, some SIPPs – Self Invested Personal Pensions – aren't, and will instead only allow UFPLS (or they'll make you transfer elsewhere to start withdrawing).
If that's all you need, great. If not, no need to panic – you can easily switch SIPP provider that one that better caters to the retirement phase. We've rounded up our top choices here.
Bottom line
Taking your tax-free pension cash is one of those decisions that feels simpler than it is. The temptation to grab the lot in one go is understandable, but as we've seen, the way you take it can make a meaningful difference to how much of your retirement income eventually ends up with HMRC rather than you.
The right approach depends on your income, your plans, and how long you need your money to work for you. And if you're not sure, getting solid financial advice is a good place to start.
Financial Interest provides guidance, not advice. If you’re unsure about anything, speak with a qualified adviser. When investing, your capital is always at risk. Past performance does not guarantee future results.
