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Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

We look at the different options regarding tax treatment on retirement savings

While the main purpose of a SIPP (self-invested personal pension) is to provide an income as you transition away from work and into retirement, for many one of the primary attractions is the 25% tax-free cash available once you start accessing your money.

If you choose to keep your money invested within the pension tax wrapper there are two primary ways to get your hands on your tax-free cash without triggering the regular income that would come with an annuity. You can take ad-hoc lump sums (sometimes referred to as Uncrystallised Funds Pension Lump Sums, or UFPLS), or enter drawdown.

To understand how each option can be used to access your tax-free money – and the possible implications – let’s consider an example.

Mrs Smith is 60 years old and holds a SIPP worth exactly £80,000. She still works part-time as a bank manager and earns £20,000 a year. She makes annual pension contributions of £2,000.

Mrs Smith is looking to withdraw £20,000 from her SIPP to help fund a deposit for her son’s new house. Because she is still working Mrs Smith doesn’t yet need to take an income from her remaining pension, preferring to leave the fund invested so it has the chance to enjoy further investment growth.


Under the first option she takes the full 25% tax-free lump sum of £20,000, leaving the remaining £60,000 invested and available to draw an income whenever she chooses, on which she’ll have to pay tax in the same way as earnings.

The second avenue open to her involves taking an ad-hoc lump sum, or UFPLS, of £23,530 from her fund.

A quarter of this (£5,882.50) is tax-free with the remainder (£17,647.50) taxed at her marginal rate (20%), giving her the £20,000 she needs for her son’s deposit (and 50p for a Curly Wurly chocolate bar).

One of the main advantages of the first option is that Mrs Smith retains the £40,000 annual allowance (maximum you can contribute to your pension each, while still receiving tax relief) until she takes any taxable income from her pot.

In the second option this will be reduced to just £4,000 (that applies once you start drawing a pension via UFPLS) – although this isn’t a problem for Mrs Smith as her annual contributions are just £2,000.

Under the second option, Mrs Smith will be left with £56,470 in her pension fund – £3,530 less than if she takes the full 25% tax-free cash. However, she will still have lots more tax-free cash available to take in the future, while in the first option she has already used the lot.

In this example there is no ‘right’ option. However, if Mrs Smith was planning to make pension contributions of more than £4,000 a year she should avoid taking taxable income from her fund because of the impact on the amount she can pay in.

Equally, if she was a higher-rate taxpayer now but expected to be a basic-rate taxpayer in retirement she might prefer to take a tax-free lump sum and then draw an income in retirement taxed at 20% – rather than taking the ad-hoc (UFPLS) payment and seeing 75% of it taxed at the higher-rate (40%).

Tom Selby, senior analyst, AJ Bell

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