Taking a quarter of a pension tax-free, and what happens to the rest

The tax-free quarter is the best-known feature of a private pension, and for many people the first thing they think about when a scheme writes to say their pension can be taken. It is real and it is valuable. It is also only a quarter: the other three quarters are taxable income, and the way the money is taken out decides how much of that income tax ends up being.

This article explains the rules for defined contribution pensions, the kind built up as a pot with a workplace scheme or a personal pension. It does not recommend any option or provider; the right choice depends on the rest of a person’s finances.

The quarter and the cap

GOV.UK states that you can usually take up to 25% of the amount built up in any pension as a tax-free lump sum, and that the most you can take is £268,275. That cap, known as the lump sum allowance, applies across all of a person’s pensions together, not to each one. People who hold a protected allowance from earlier pension tax rules may be able to take more. A separate, larger limit, the lump sum and death benefit allowance, covers tax-free lump sums including those paid on death.

The earliest age at which a private pension can normally be taken is 55. It is due to rise to 57 from 6 April 2028, though some scheme members have a protected lower pension age.

Four ways to take it

For a defined contribution pot, the main routes are these. Each treats the tax-free part slightly differently.

Summary for defined contribution pensions. Defined benefit (final salary) schemes usually offer a tax-free lump sum in exchange for a lower pension, on terms set by the scheme.

Annuities and drawdown are compared in more detail in annuity or drawdown, set out without the sales pitch. Small pots can also sometimes be taken as a single small lump sum, of which 25% is tax-free.

What happens to the rest

Whatever route is taken, the taxable 75% is added to the person’s other income for the tax year in which it is received, alongside the State Pension, any other pensions and any earnings. It is taxed at their usual rates. In England, Wales and Northern Ireland for 2026/27, the Personal Allowance is £12,570, basic rate tax of 20% applies to the next £37,700, and higher rate tax of 40% applies above £50,270. Scotland has its own bands for this kind of income.

That is why the timing matters. The full new State Pension, £12,547.60 a year in 2026/27, already uses almost all of the Personal Allowance on its own, so for many retired people every taxable pound taken from a pot is taxed from the first pound.

The tax-free percentage never changes. What changes is how much of the remainder lands in a higher tax band.

The allowance that shrinks after taxable withdrawals

Once someone starts taking taxable money flexibly, either cash in chunks or income from a drawdown fund, the amount they can pay into defined contribution pensions each year with tax relief usually drops to the money purchase annual allowance of £10,000. GOV.UK lists those two types of withdrawal as triggers. This matters mainly to people who are still working and still contributing, or whose employer still pays in. Taking only the tax-free lump sum and leaving the rest invested in drawdown does not, on its own, trigger the lower allowance.

Tax taken on the first withdrawal

When the first taxable sum is paid, the provider often has no up-to-date tax code and deducts tax as if the same payment would be made every month. Too much tax is commonly taken. It can be reclaimed within the year, using one of three HMRC forms, as explained in why a first pension withdrawal is often taxed too much.

Who this matters for, and what to check

• Anyone aged 55 or over with a defined contribution pot who has received a “retirement options” pack from a provider.
• People who are still working and contributing, because of the money purchase annual allowance.
• People with several old pots, who may not know where they all are. See tracking down a pension from a job you left years ago.
• Anyone who wants an impartial view: Pension Wise, from the government-backed MoneyHelper service, offers a free guidance appointment to people aged 50 or over with a defined contribution pension.

The takeaway

A quarter of a pension can usually be taken without tax, up to £268,275 in total. The decision that matters is what happens to the other three quarters: taken all at once it may be taxed at 40%, taken gradually it may be taxed at 20%, and taken flexibly it limits future pension saving. None of that is a reason to rush, and none of it requires paying anyone for a “release” service.