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Maximising Tax-Free Cash: Lump Sum vs Drip-Feed Drawdown
Tax free cash
Most retirees can take up to 25% of their pension savings tax free, with this option being one of the most cherished features of private pension saving. As a result, few people want to miss out on taking their tax-free cash and the majority take their full entitlement at the point that they first access their pension.
For those taking a scheme pension or purchasing a lifetime annuity, they have a binary choice – either take the tax-free cash or take a higher taxable income. However, for those looking to access their pension more flexibly, there is a third option to take the tax-free cash gradually, under ‘drip-feed drawdown’.
For retirees who don’t need the full lump sum immediately (for example, to pay off mortgage/debts), this third option can help maximise retirement income and the inheritance available for family and friends.
Case study - Trevor (60)
Trevor is retiring with a £450,000 pension fund. He wants to use his tax-free cash to pay for a dream holiday and home improvements, which will cost £20,000. He has finished paying his mortgage and will need an income of £2,500 a month (£30k a year) after tax. He will initially fund this from his pension (through drawdown) until he qualifies for a full state pension at age 67, which will then part fund the income requirement.
Scenario 1 - Trevor takes his full tax-free cash entitlement of £112,500. After paying for his holiday and home improvements, the remainder (£92,500) will be placed in a savings account for emergencies:
| Age | Uncrystallised fund* | Drawdown fund* | 25% tax free lump sum | Drawdown income | State Pension** | Personal Allowance*** | Income Tax @ 20%**** | Total Tax free cash & net income |
|---|---|---|---|---|---|---|---|---|
| 60 | £0 | £303,143 | £112,500 | £34,358 | £0 | £12,570 | £4,358 | £142,500 |
| 61 | £0 | £280,911 | £0 | £34,358 | £0 | £12,570 | £4,358 | £30,000 |
| 62 | £0 | £257,790 | £0 | £34,358 | £0 | £12,570 | £4,358 | £30,000 |
| 63 | £0 | £233,822 | £0 | £34,279 | £0 | £12,884 | £4,279 | £30,000 |
| 64 | £0 | £208,977 | £0 | £34,198 | £0 | £13,206 | £4,198 | £30,000 |
| 65 | £0 | £183,220 | £0 | £34,116 | £0 | £13,537 | £4,116 | £30,000 |
| 66 | £0 | £156,517 | £0 | £34,031 | £0 | £13,875 | £4,031 | £30,000 |
| 67 | £0 | £143,066 | £0 | £19,712 | £14,232 | £14,222 | £3,945 | £30,000 |
| 68 | £0 | £129,521 | £0 | £19,268 | £14,588 | £14,577 | £3,856 | £30,000 |
| 69 | £0 | £115,890 | £0 | £18,812 | £14,953 | £14,942 | £3,765 | £30,000 |
| 70 | £0 | £102,180 | £0 | £18,345 | £15,326 | £15,315 | £3,671 | £30,000 |
| 71 | £0 | £88,402 | £0 | £17,866 | £15,710 | £15,698 | £3,575 | £30,000 |
| 72 | £0 | £74,563 | £0 | £17,375 | £16,102 | £16,091 | £3,477 | £30,000 |
| 73 | £0 | £60,674 | £0 | £16,872 | £16,505 | £16,493 | £3,377 | £30,000 |
| 74 | £0 | £46,744 | £0 | £16,356 | £16,918 | £16,905 | £3,274 | £30,000 |
| 75 | £0 | £32,787 | £0 | £15,828 | £17,340 | £17,328 | £3,168 | £30,000 |
| 76 | £0 | £18,812 | £0 | £15,286 | £17,774 | £17,761 | £3,060 | £30,000 |
| 77 | £0 | £4,834 | £0 | £14,730 | £18,218 | £18,205 | £2,949 | £30,000 |
| 78 | £0 | £0 | £0 | £5,028 | £18,674 | £18,660 | £1,008 | £22,693 |
*assumes 4% investment return achieved net of charges. Income requirement taken annually in advance.
** assumes full state pension rises by 2.5% per year from 2025/26 level - £11,973 a year.
*** assumes personal allowance is frozen for first 3 years and then rises by 2.5% per year from 6 April 2028.
**** assumes basic rate tax at 20% charged on income above personal allowance.
This approach should allow Trevor to meet his income requirement until age 78, after which his pension fund would run out and he would become fully reliant on the state pension and other savings.
Trevor still has the remaining £92,500 of unused tax-free cash (plus interest earned), which can be used to make up any future income shortfall or provide an inheritance to loved ones on death.
Scenario 2 – In this example, Trevor only takes £20,000 of his tax-free cash entitlement to cover the holiday and home improvements. He then uses drip-feed drawdown via a combination of tax-free cash and drawdown income to provide his income needs in a tax efficient manner. For simplicity, this scenario is based on taking income annually, although in practice Trevor is likely to opt for a monthly income, leaving more of his fund invested for longer:
| Age | Uncrystallised fund* | Drawdown fund* | 25% tax free lump sum | Drawdown income | State Pension** | Personal Allowance*** | Income Tax @ 20%**** | Total Tax free cash & net income |
|---|---|---|---|---|---|---|---|---|
| 60 | £300,280 | £99,720 | £37,430 | £12,570 | £0 | £12,570 | £0 | £50,000 |
| 61 | £242,571 | £143,429 | £17,430 | £12,570 | £0 | £12,570 | £0 | £30,000 |
| 62 | £182,554 | £188,886 | £17,430 | £12,570 | £0 | £12,570 | £0 | £30,000 |
| 63 | £121,393 | £234,904 | £17,116 | £12,884 | £0 | £12,884 | £0 | £30,000 |
| 64 | £59,074 | £281,475 | £16,794 | £13,206 | £0 | £13,206 | £0 | £30,000 |
| 65 | £0 | £323,895 | £15,359 | £14,917 | £0 | £13,537 | £276 | £30,000 |
| 66 | £0 | £302,820 | £0 | £34,031 | £0 | £13,875 | £4,031 | £30,000 |
| 67 | £0 | £295,220 | £0 | £19,712 | £14,232 | £14,222 | £3,945 | £30,000 |
| 68 | £0 | £287,761 | £0 | £19,268 | £14,588 | £14,577 | £3,856 | £30,000 |
| 69 | £0 | £280,460 | £0 | £18,812 | £14,953 | £14,942 | £3,765 | £30,000 |
| 70 | £0 | £273,334 | £0 | £18,345 | £15,326 | £15,315 | £3,671 | £30,000 |
| 71 | £0 | £266,401 | £0 | £17,866 | £15,710 | £15,698 | £3,575 | £30,000 |
| 72 | £0 | £259,682 | £0 | £17,375 | £16,102 | £16,091 | £3,477 | £30,000 |
| 73 | £0 | £253,198 | £0 | £16,872 | £16,505 | £16,493 | £3,377 | £30,000 |
| 74 | £0 | £246,969 | £0 | £16,356 | £16,918 | £16,905 | £3,274 | £30,000 |
| 75 | £0 | £241,021 | £0 | £15,828 | £17,340 | £17,328 | £3,168 | £30,000 |
| 76 | £0 | £235,376 | £0 | £15,286 | £17,774 | £17,761 | £3,060 | £30,000 |
| 77 | £0 | £230,060 | £0 | £14,730 | £18,218 | £18,205 | £2,949 | £30,000 |
| 78 | £0 | £225,102 | £0 | £14,161 | £18,674 | £18,660 | £2,835 | £30,000 |
| 79 | £0 | £220,528 | £0 | £13,578 | £19,141 | £19,127 | £2,718 | £30,000 |
| 80 | £0 | £216,370 | £0 | £12,980 | £19,619 | £19,605 | £2,599 | £30,000 |
| 81 | £0 | £212,658 | £0 | £12,367 | £20,110 | £20,095 | £2,476 | £30,000 |
| 82 | £0 | £209,426 | £0 | £11,738 | £20,612 | £20,597 | £2,351 | £30,000 |
| 83 | £0 | £206,709 | £0 | £11,094 | £21,128 | £21,112 | £2,222 | £30,000 |
| 84 | £0 | £204,543 | £0 | £10,434 | £21,656 | £21,640 | £2,090 | £30,000 |
| 85 | £0 | £202,967 | £0 | £9,757 | £22,197 | £22,181 | £1,955 | £30,000 |
| 86 | £0 | £202,022 | £0 | £9,064 | £22,752 | £22,736 | £1,816 | £30,000 |
| 87 | £0 | £201,750 | £0 | £8,353 | £23,321 | £23,304 | £1,674 | £30,000 |
| 88 | £0 | £202,196 | £0 | £7,624 | £23,904 | £23,887 | £1,528 | £30,000 |
| 89 | £0 | £203,406 | £0 | £6,877 | £24,502 | £24,484 | £1,379 | £30,000 |
| 90 | £0 | £205,430 | £0 | £6,112 | £25,114 | £25,096 | £1,226 | £30,000 |
| 91 | £0 | £208,320 | £0 | £5,327 | £25,742 | £25,723 | £1,069 | £30,000 |
| 92 | £0 | £212,130 | £0 | £4,523 | £26,386 | £26,366 | £908 | £30,000 |
| 93 | £0 | £216,917 | £0 | £3,698 | £27,045 | £27,026 | £744 | £30,000 |
| 94 | £0 | £222,741 | £0 | £2,853 | £27,721 | £27,701 | £575 | £30,000 |
| 95 | £0 | £229,663 | £0 | £1,987 | £28,414 | £28,394 | £402 | £30,000 |
| 96 | £0 | £237,750 | £0 | £1,099 | £29,125 | £29,104 | £224 | £30,000 |
| 97 | £0 | £247,071 | £0 | £189 | £29,853 | £29,831 | £42 | £30,000 |
| 98 | £0 | £256,954 | £0 | £0 | £30,599 | £30,577 | £4 | £30,595 |
| 99 | £0 | £267,232 | £0 | £0 | £31,364 | £31,341 | £5 | £31,360 |
| 100 | £0 | £277,921 | £0 | £0 | £32,148 | £32,125 | £5 | £32,144 |
*assumes 4% investment return achieved net of charges. Income requirement taken annually in advance.
** assumes full state pension rises by 2.5% per year from 2025/26 level - £11,973 a year.
*** assumes personal allowance is frozen for first 3 years and then rises by 2.5% per year from 6 April 2028.
**** assumes basic rate tax at 20% charged on income above personal allowance.
This approach allows Trevor to meet his income requirement indefinitely. In fact, the drawdown fund is projected to start increasing in value again after age 88 - this will give Trevor scope to draw additional income to account for rising costs (due to inflation) and/or leave a significant legacy to family and friends when he dies.
Comment
Drawing tax free cash at the earliest opportunity can mean missing out on valuable investment returns and paying more tax, which can make it more difficult to obtain a comfortable retirement.
In many cases, it will make sense to draw tax free cash gradually, leaving more of the pension fund and tax-free cash entitlement to grow in a tax privileged environment until such time as it is needed.
Note that drip-feed drawdown won’t be suitable or may not be possible where a protected retirement age or protected tax-free cash is present. In addition, sufficient Lump Sum Allowance (LSA) and Lump Sum and Death Benefit Allowance (LSDBA) will be needed.
Important information
Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.
The tax treatment of benefits depends on individual circumstances and may be subject to change in the future.
The use of this document is at your own risk, and the content should not be used for the provision of professional advice.
LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.