HMRC has clarified the tax rules that apply when you take a lump sum from your pension. The guidance follows a question from a pensioner in their 60s who contacted the tax authority on social media to ask how their pension payments would be taxed, saying they had already used up their tax-free lump sum allowance.
How pension lump sums are taxed
When taking money from your pension above your tax-free allowance, tax is deducted automatically using a specific formula. HMRC said: "If you're taking a pension lump sum, the first 25 per cent is tax free and the remaining is taxed on a week 1 month 1 basis."
Under this approach, your lump sum is treated as an isolated payment. This means the tax calculation does not factor in your other earnings or any other tax you have paid in that same tax year.
Taking multiple tax-free amounts
You can withdraw up to 25 per cent of each pension pot you hold tax-free, up to a maximum cap of £268,275 across all your pots. HMRC also explained how you can use this 25 per cent rule across several pots.
The authority said: "You can take your 25 per cent tax-free pension amount more than once by using phased drawdown or taking multiple smaller lump sums from a single pot, or by accessing multiple separate pension pots." Once you go over the 25 per cent tax-free limit, any additional lump sum money is added to your income and taxed at your marginal income tax rate.
Income tax bands in Wales
This is how the income tax rules work in Wales:
- Personal allowance: Up to £12,570 of income is tax-free each year.
- Basic rate - 20 per cent - On income from £12,571 to £50,270.
- Higher rate - 40 per cent - On income from £50,271 to £125,140.
- Additional rate - 45 per cent - On income above £125,140.
- Personal allowance reduction - Once your income moves above £100,000, you lose £1 of this allowance for every £2 you earn above £100,000, losing it completely at £125,140.
Pension access rule changes
People planning for their retirement may want to note some key changes come up regarding when they can access their pensions. The age at which you can access your private pensions, including withdrawing a lump sum, is increasing from the current 55 to 57. This change will come into effect from April 2028.
Another change from April 2028 is that the state pension age will complete its transition to 67. The state pension age is currently moving up from 66 to 67, going up in stages between April 2026 and April 2028.
