How the 25% actually works

The rule people remember is that a quarter of a pension comes out tax free. That is broadly right for defined-contribution pots, the kind built up from contributions rather than a promise of income. What trips people up is that the 25% applies per pot, not once across your whole retirement. If you hold four pensions you have four separate quarters, and you do not have to take them at the same time.

You can take the tax-free part in one go, or in slices. Take it in slices and 25% of each withdrawal is tax free and the rest is taxed as income. Take it all at once and the remaining 75% sits there waiting to be taxed whenever you draw it. Neither is automatically better. It depends on what other income you have in the same tax year.

When you can take it

The normal minimum pension age is 55. It rises to 57 on 6 April 2028, and that change catches people who planned around turning 55 in 2028 or 2029. A handful of older schemes carry a protected earlier age, which is written into the scheme rules rather than something you can apply for.

Serious ill health can allow earlier access. That is a scheme-by-scheme judgement and it usually requires medical evidence, so it is not a route to plan around.

The cap most people have never heard of

There is a ceiling on the total tax-free cash you can take across every pension you hold. For most people that ceiling is £268,275. It is not per pension, it is per person, and once you have used it the rest comes out taxable no matter how many pots you have.

Most people will never get near it. If your pensions total under about a million pounds it is unlikely to bite. If you have been a high earner, or you hold a generous public-sector pension alongside private pots, it is worth checking before you take anything, because the order you draw pensions in can change what you have left.

What it costs you to take it early

Money inside a pension grows without income tax or capital gains tax. Money in your current account does not. Taking tax-free cash you have no immediate use for moves it from the first situation to the second, permanently, because you cannot put it back beyond the normal contribution limits.

There is a second cost that is easier to miss. Taking only tax-free cash does not usually trigger it, but taking any taxable income from a pot cuts how much you can pay into pensions afterwards, down to the Money Purchase Annual Allowance. If you are still working and still contributing, that can cost you more than the cash was worth.

When taking it makes sense, and when it does not

It usually makes sense when the money has a job to do. Clearing a mortgage or expensive credit balances gives you a guaranteed return equal to the interest rate you stop paying, which is hard to beat. Funding a gap between stopping work and the State Pension starting is another sound use.

It usually does not make sense when the answer to what you will do with it is that you are not sure. Cash sitting in a low-interest account loses value to inflation while the same money left invested might not have. And if you claim or expect to claim means-tested benefits, a lump sum sitting in savings can reduce or remove them, which is the single most expensive mistake in this area.

A worked example: Three pots, one decision

Sarah is 57 and holds three defined-contribution pensions worth £40,000, £85,000 and £120,000. She assumes she can take 25% once. In fact each pot has its own quarter, so £10,000, £21,250 and £30,000 are available tax free, £61,250 in total, and she does not have to take them in the same year.\nShe needs £20,000 to clear a car loan charging 9%. Taking it from the smallest pot leaves the other two untouched and still sheltered. Clearing 9% debt is a certain return she is unlikely to beat by leaving that £20,000 invested, so this is a sound use. Emptying all three because she is entitled to would not be.

Figures are illustrative and rounded, used to show how the rule works. Your own numbers will differ.

A second example: Why the order you draw matters

Ian has £900,000 across four pensions. Taken together, 25% would be £225,000, comfortably inside the lump sum allowance. He takes tax-free cash from two pots and leaves the others.\nFive years later the remaining pots have grown, and the quarter available from them has grown with them. Because the allowance is a fixed cash figure rather than a percentage, growth after you start drawing can push the total available tax-free cash against the ceiling. Anyone near it should map the order and timing before taking the first payment, not after.

At a glance

Common mistakes

• Assuming the 25% is once across your whole retirement rather than per pot.
• Taking the cash with no plan for it, so it sits earning less than it would have inside the pension.
• Forgetting that a lump sum in the bank counts for means-tested benefits, while money still in a pension often does not.
• Triggering the Money Purchase Annual Allowance by taking taxable income at the same time.

What to do next, in order

1. List every pension you hold and note whether each is defined contribution or defined benefit.
2. Ask each scheme what tax-free cash it would pay and whether any protection applies.
3. Add up the tax-free cash across all of them and compare it with the lump sum allowance.
4. Decide what the money is actually for before you take a penny of it.
5. If you are still working and contributing, check the effect on your annual allowance first.

Key terms, in plain English

Tax-free cash

The part of a pension you can normally take without paying income tax, usually 25% of a defined-contribution pot.

Lump sum allowance

The ceiling on total tax-free cash across all your pensions, £268,275 for most people.

Defined contribution

A pension built from contributions and investment growth. What you end up with depends on what went in and how it performed. Most modern workplace and personal pensions are this type.

Normal minimum pension age

The earliest age you can normally take a private pension. Currently 55, rising to 57 on 6 April 2028.

Money Purchase Annual Allowance

A much lower annual contribution limit that applies once you take taxable income flexibly from a defined-contribution pension.

Who this affects most

This matters most to anyone holding more than one defined-contribution pot, because the per-pot quarter is where the planning opportunity sits. It matters urgently to anyone with total pensions approaching a million pounds, since the lump sum allowance starts to bite. And it matters to anyone claiming means-tested support, where cash in the bank is assessed and pension money generally is not. If you hold a single small pot, are well short of the allowance and claim nothing, the decision is simpler than this page makes it sound.

Common questions

Where to check the official figures

Pension figures change every tax year. These are the free, official sources. Check the current number before you act on anything here.

• Check your State Pension forecast, GOV.UK
• Check your National Insurance record, GOV.UK
• Pension Tracing Service, GOV.UK
• MoneyHelper, pensions and retirement
• The FCA Register, check any firm

Where to go next

• Combining pensions: our main guide
• The NHS Pension Scheme explained
• The LGPS explained
• The Teachers’ Pension Scheme explained

The bottom line

We do not provide pension advice and we are not pension advisers. We introduce you to a carefully selected, FCA-regulated pension adviser. The introduction costs you nothing. If you go ahead, we may be paid a fee by that firm. Pension rules and figures change, and what is right depends on your own circumstances.