In our weekly series, readers can email in with any questions about retirement and pension savings to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he does not know about pensions. If you have a question for him, email us at money@theipaper.com
Question: I am looking to start claiming my NHS pension – early – in February 2027 and want to fully understand the tax implications. I am today, and will remain in, full-time employment earning about £40,000 per year, although I’m not working for the NHS any more. I will claim my pension, which will give me about £15,000 a year, plus a one-off tax-free lump sum somewhere in the region of £110,000 to £120,000. One thing I am unclear on is whether, although tax-free initially, the lump sum, coupled with my annual salary from work and annual pension, would take my total income for the year to a level that means I’d lose my personal allowance and then owe HMRC some money at the end of the year?
Answer: Let’s quickly cover off how your pension, including the lump sum element, works before diving into the income tax rules. Your NHS pension, which you have built entitlement to, is defined benefit (DB) meaning you will receive a portion of your salary as an NHS employee as a guaranteed, inflation-protected retirement income for life from what’s known as your normal retirement age.
The level of income you receive will depend on the accrual rate of the scheme and whether the scheme was operating on a career average or final salary basis when you were a member. If it was a career average scheme with a 1/60ths accrual rate, for example, then someone who was a member of the scheme for 20 years with an average salary of £60,000 would be entitled to a DB pension of £20,000 a year from the scheme’s normal retirement age. For the NHS scheme this will depend on when you built up your benefits, although for the current scheme (in place since 2015) it is the state pension age.
If you have built up some of your pension on final salary terms and some on career average terms with the same employer, as could be the case as you were in an NHS scheme that switched from the former to the latter in 2015, you should receive your pension as promised when you were in the scheme. So, if, for example, you had built up 10 years of pension on final salary terms, these should be honoured when you come to receive your retirement income.
DB pension schemes such as this often offer you the option of taking a tax-free lump sum when you start receiving your income. The level of tax-free lump sum you can take will vary from scheme to scheme, as will the impact of taking that lump sum.
Some, for example, will offer a lump sum as standard that is simply a multiple of your promised pension, while others will allow you to take the lump sum but will apply a reduction to the pension income you receive for the rest of your life. If this is the case, it’s important to consider the impact of this on your long-term retirement plans when deciding how much tax-free cash you want to take.
The income tax rules you are referring to are the tapering of the £12,570 personal allowance for people earning over £100,000. Under HMRC rules, you lose £1 of personal allowance for every £2 of taxable income you earn above £100,000, meaning someone with income of £125,240 in 2026/27 loses all their personal allowance.
HMRC counts things like earned income and pension income (including your state pension entitlement) when determining if your personal allowance will be reduced but, crucially, any pensions tax-free cash you receive will not have any impact.
So, based on the details you have provided, you should still be entitled to your full £12,570 personal allowance when you take your tax-free lump sum (assuming your other taxable income sources don’t rise substantially).
