Tax on a pension lump sum: the 25% rule and what the other 75% costs

A pension lump sum is normally 25% tax-free, with the balance taxed as pension income at the member’s marginal rate under ITEPA 2003 s.579A (PTM063300). There are two ways to take one from a money-purchase pot — a pension commencement lump sum (PCLS) or an uncrystallised funds pension lump sum (UFPLS) — and the 25% rule wears a different shape in each. The expensive questions are on the other 75%: which band it lands in, and whether it drags the personal allowance down with it.

The PCLS and its permitted maximum

A PCLS is paid tax-free up to the permitted maximum (PTM063210 / PTM063230): broadly 25% of the value crystallised alongside it, capped at the member’s remaining lump sum allowance. Crystallise £200,000 into drawdown and the permitted maximum is £50,000 — paid free of tax, with the £150,000 balance designated to drawdown and taxed only as it is later drawn. A PCLS on its own triggers no income tax and, taken without any drawdown income, is not a trigger for the money purchase annual allowance (PTM056530).

The £268,275 ceiling

Since 6 April 2024 the tax-free total is capped for a lifetime by the lump sum allowance — £268,275 as standard (FA 2024 Sch 9; PTM171000). Every PCLS, and the tax-free element of every UFPLS, consumes it. Once the allowance is exhausted, further “tax-free” cash is simply taxed at the member’s marginal rate — the old lifetime-allowance charges no longer exist. Members holding lifetime-allowance protection keep higher figures. The Lump Sum Allowance calculator tests a specific lump sum against what remains.

FA 2024 Sch 9 ; PTM171000 ; PTM063210 / PTM063230.

UFPLS or PCLS: the same split, differently timed

An UFPLS folds the split into every payment: 25% tax-free (capped at the available lump sum allowance), 75% taxable, payment by payment (PTM063300; FA 2004 Sch 29 para 4A; the allowance available is read under para 12A). A PCLS front-loads the whole tax-free element and leaves the taxable balance invested until drawn. Before investment growth, the tax-free and taxable totals over a fully-withdrawn pot match; what differs is timing — growth on funds left uncrystallised keeps a 25% tax-free share, growth inside drawdown does not — and one further consequence: an UFPLS is a money purchase annual allowance trigger, while a PCLS alone is not (PTM056530).

What the taxable 75% costs

The taxable element is non-savings pension income and is taxed at whatever marginal position it lands in. The worked examples run a £40,000 UFPLS — £10,000 tax-free, £30,000 taxable — at two income levels (2026/27, rUK):

The same slice costs 20% or 40% depending on nothing but the income it sits on. The pension withdrawal tax calculator computes the attributable figure for any combination; the UFPLS calculator handles the split and the allowance tests.

The £100,000 straddle

The taxable element counts in adjusted net income, so a lump sum can carry the member across £100,000 and strip the personal allowance at £1 for every £2 above it (ITA 2007 s.35). On £90,000 of other income, the same £30,000 slice lifts adjusted net income to £120,000, cuts the allowance from £12,570 to £2,570, and costs £16,000 — an effective 53.3%: £12,000 at 40% on the slice itself, plus £4,000 at 40% on the £10,000 of allowance it withdrew. A lump sum that straddles the threshold is taxed materially worse than the headline rate suggests, and the effect is invisible until the allowance is recomputed.

ITA 2007 s.35 ; ITEPA 2003 s.579A ; PTM063300.

One more rule: the cash cannot loop back

Paying the tax-free cash back into a pension as a significantly increased contribution can make the whole lump sum an unauthorised payment charged at 40%, with a further 15% surcharge in some cases — the recycling rule (FA 2004 Sch 29 para 3A; PTM133810). The gates are cumulative tax-free cash above £7,500 in a rolling twelve months and additional contributions above 30% of the lump sum concerned, as part of a pre-planned arrangement. The conditions and worked charges are in the pension recycling rules; the wider withdrawal picture is in pension withdrawals: how taking money out is taxed.