Am I entitled to a lump sum on retirement?

1995 section members and 2008 section optants via the Choice exercise

1995 section members will automatically be entitled to a standard lump sum of three times your pension. If you are a 2008 section optant the mandatory lump sum is based on benefit accrual on moving to the 2008 section based on service to 31 March 2008.

The lump sum will be less than three times the pension for:

• married men with service prior to 25 March 1972
• women who opted for a bigger widower’s pension
• individuals who opted for increased dependents benefits in the 1995 section, unless an unreduced lump sum has been purchased.

Further to the legal decision in the Goodwin case, all survivor benefits for spouses and civil partners are to be equalised from 1 December 2005. Any purchases relating to bullet points 2 and 3 above (for deaths occurring after that date) should be reimbursed.

2008 and 2015 sections

Whilst there is no standard lump sum, you can choose whether to access a lump sum by giving up some of your annual pension at a rate of £1 of pension for £12 of lump sum. This is known as commutation of benefits.

When your lump sum will be paid

• Your lump sum is usually paid to you the day after your retirement, providing you have completed the application in good time.
• If you are retiring from the NHS pension scheme (England and Wales) the payment of your lump sum will be made within 30 days of your retirement date.
• If the payment is made outside of 30 days interest may be payable.

Commutation of pension benefits

When you come to make your application for retirement, you will decide if you want to commute annual pension in favour of a lump sum.

Commutation is the option to access a retirement lump (2008 section and 2015 scheme members) or an increased lump sum (1995 section members or 2008 section optants) by forgoing £1 of index linked pension for £12 of lump sum.

While it can be tempting to take a lump sum, you will need to weigh up the benefits and consider the value for money. For example, for every £12,000 of lump sum you take, you give up £1,000 index linked annual pension for life.

If you have separate benefits in the 1995 and/or 2008 sections and in the 2015 scheme, you are able to make separate decisions about the commutation of benefits. This does not apply when accessing benefits on the grounds of ill health retirement in England and Wales.

Maximum tax free lump sum

The Spring Budget 2023 announced the abolition of the Lifetime Allowance Charge with charges removed from 6 April 2023 and the abolition of the Lifetime Allowance itself from 6 April 2024. However, the Pension Commencement Lump Sum has been retained as a Lump Sum Allowance (LSA) pegged at £268,275 (25% of the last LTA of £1,073,100). If individual protections are held then the maximum tax free amount is 25% of the protected amount. Any excess lump sum taken above the LSA will be taxed at the individual’s marginal income tax rates.

Since the abolition of the LTA the standard (default) calculation of tax free lump sum usage for those who have taken benefits prior to 6 April 2024 will be 25% of the LTA used.  This is the case even where no lump sum has been taken.

Where you have further benefits to take after 6 April 2024 and the standard calculation of lump sum usage detailed above does not allow for any further tax free lump sum the alternative calculation can help.  This enables those who can detail the exact amounts of tax free cash taken on retirement, via a Transitional Tax Free Amount certificate, to have the exact amounts taken as tax free lump sums deducted from the limit of £268,275 (rather than the assumed 25% of the LTA already used).  This can increase the amount of tax free lump sum available.  

HMRC information on the LSA can be found here.

Where you have several pensions and your situation is complex you may need to seek independent financial advice to ensure the best course of action is taken.

1995 section

The maximum lump sum available is 25% of the capital value of your benefits (the tax free element is restricted to no more than the LSA of £268,275 or any protected amount if greater) and can be estimated by multiplying your pension by 5.36. The automatic standard lump sum is included when calculating the 25% total available to you.

For example, if you have a pension of £25,200 and a standard lump sum of £75,600, the lump sum could be maximised as follows:

£25,200 x 5.36 (commutation factor for 1995 section) = £135,072 approximate maximum lump sum

£135,072 - £75,600 (basic lump sum) = £59,472 maximum additional lump sum

£59,472/12 = £4,956 reduction in annual pension required to fund this.

2008 section and 2015 scheme

The maximum amount available is 25% of the capital value of your benefits (the tax free element is restricted to no more than the LSA of £268,275 or any protected amount if greater) and can be estimated by multiplying your pension by 4.28. Any 2008 section choice mandatory lump sum is also included when calculating the 25% total available to you.

For example, if you have a pension of £33,660 the lump sum could be maximised as follows:

£33,660 x 4.28 (commutation factor for 2008 section and 2015 scheme) = £144,060 approximate maximum lump sum (rounded down to the nearest number divisible by 12)

£144,060/12 = £12,005 reduction in annual pension required to fund this.

If the maximum lump sum of £144,060 was taken the annual pension would be reduced to £21,655 (£33,660 less £12,005).

For a 2008 choice optant, the calculation of the maximum lump sum would be based on 4.28 of the standard pension, deducting the mandatory lump sum, to give the additional amount of pension available.

It is not necessary to take the maximum lump sum. It is possible to access any amount of lump sum up to the maximum of 25% of the total pension value, limited to the LSA limit of £268,275 or a protected amount if greater)by giving up a part of the annual pension as detailed above.

Is my lump sum always tax-free?

You are entitled to a tax-free lump sum of no more than the LSA  of £268,275 or 25% of your protected amount if greater).

Lump sum benefits up to this level are tax-free.

If you have a lump sum protection certificate (certified by HMRC) you will be able to access a greater tax-free lump sum than the LSA of £268,275.

If you have individual protection you are entitled to access 25% of your protected (individual) lifetime allowance.

If you have fixed protection you are entitled to access 25% of your protected (fixed) lifetime allowance.

It is possible to apply for Individual and Fixed protections 2016 (where any relevant criteria is met) up to 5 April 2025.

If you have enhanced or primary protection you are entitled to access 25% of £1.5m as your lump sum before any tax charges will apply.

Any lump sum which exceeds this limit will be subject to taxation at your marginal rate of income tax.

Is the lump sum likely to ever be taxed in future?

While we can’t predict what any Governments may announce in future, it is in the Government’s interest for people to take their pensions in a lump sum.

​If the Government were to decide to tax the lump sum, presumably fewer people would choose to access benefits in this way. With fewer people opting for lump sums, the scheme would retain a greater liability for paying ongoing index linked pension benefits and would be more ‘expensive’ as a result of this.

Making another commutation choice

Your pension commutation options are:

• taking standard benefits (no commutation)
• taking the maximum tax free lump sum only (increasing it to 25% of the capital value of your benefits limited to the LSA limit of £268,275 or a protected amount if greater)
• taking the maximum lump sum (only available if you are able to take a lump sum of more than 25% of the standard lifetime allowance/personal lifetime allowance)
• taking an amount specified by you up to the maximum lump sum possible.

The option to exchange part of your pension for lump sum must be made at the time of claiming your pension. For that reason you will not have a second opportunity to make a decision about commutation even if a substitute award be made.

The approach taken by the NHS pensions agencies is:

• if when claiming the pension you opted to take the maximum lump sum, the pensions agencies will apply that decision to all substitute awards
• if when claiming the pension you opted to commute a fixed amount (or nothing at all), there will be no further commutation on the additional pension resulting from the substitute award.

If you change your mind, you will need to contact the relevant pensions agency quickly and certainly before they start processing your retirement benefits.