Pension lump sum calculator — methodology

The calculation, in order

1. Split the withdrawal at the tax-free rate.
2. Add the taxable part to other income and compute income tax on the total.
3. Compute income tax on the other income alone.
4. Subtract. The difference is what the lump sum costs.
5. Repeat with the taxable part divided across two to five tax years.
6. Separately, compute what a month 1 emergency code deducts from the payment.

tax free   = amount × taxFreeLumpSumRate
taxable    = amount − tax free

tax        = incomeTax(other income + taxable) − incomeTax(other income)

over n years, each slice = taxable ÷ n
tax(n)     = n × [ incomeTax(other income + slice) − incomeTax(other income) ]

There is no tax arithmetic here. Every income tax figure is a difference between two engine answers, and the one multiplication — the tax-free split — uses the package’s own rounding so it matches every other rate applied on this site.

Why one large withdrawal costs more than the same money in two

Above £100,000 of total income the personal allowance is withdrawn by £1 for every £2 of income. So a pound of income in that stretch carries its own tax and exposes another 50p that the allowance used to cover: the rate on it is one and a half times whatever band rate applies.

A lump sum is the commonest way an ordinary income reaches that stretch. On £30,000 of other income, taking £100,000 costs £26,946.00 and takes £2,500.00 of personal allowance with it. Split across two tax years, neither half reaches the taper, and the total falls to £21,892.00 — a saving of £5,054.00 for a change of timing and nothing else.

And it does not always work, which is why the page computes it rather than advising it. The same reader taking £40,000 instead pays £7,946.00 in one year and saves £1,946.00 by splitting it. The saving comes from keeping a slice below a threshold; where no threshold is crossed, there is nothing to keep below.

The spread table runs to five years so the saving can be seen flattening out. Almost all of it arrives with the first split. A table stopping at two would read as “spreading saves money”, and a reader who took “spread it as far as possible” from this page would have been told something the arithmetic does not say.

Why this is not a projection, and why that matters for what the page may claim

A comparison between this tax year and later ones looks like a forecast, and it is not. Nothing on this page grows. There is no return assumed on the money left in the pension, no term, no inflation and no future balance — each row applies published rules to money that already exists.

What the comparison does assume is stated rather than smuggled: every year uses the selected year’s rules, because a future year’s rates are not published and would have to be invented; and other income is taken to be unchanged in each year, which for somebody about to retire is often the least safe assumption on the page. Both are on the calculator beside the table.

The consequence for what this page is allowed to say: it carries the verification stamp and the Open Government Licence attribution, because every figure on it is a published rate, threshold or allowance — and it does not carry the not-a-forecast framing, because it forecasts nothing. Attaching that framing here would imply the tax-free rate and the bands were assumptions rather than statute.

The month 1 emergency code, computed exactly rather than approximated

A first flexible withdrawal is normally taxed on a month 1 (non-cumulative) basis: the provider has no tax code for the member and cannot see their other income, so it gives one twelfth of the personal allowance and one twelfth of each band and applies them to that single payment — as though the same payment were going to arrive in every remaining month of the year.

That could be implemented by walking the bands at a twelfth of their width. It is not, because income tax is positively homogeneous in its schedule: scale the income and every threshold and allowance by the same factor and the tax scales with them. A month 1 code is exactly the annual schedule divided by twelve, so

month 1 tax on payment P  =  incomeTax(12 × P) ÷ 12

which means the figure comes out of computeTaxPosition like every other tax figure on this site, rather than out of a second implementation of the band walk living in a page. That is the whole reason applySchedule is not exported from the package: a page holding its own band walk is a page that can disagree with the engine.

The residual is at most a penny, because the engine rounds each band to whole pence before this divides by twelve, and a real payslip rounds in its own way. On the calculator’s opening figures the code would deduct £32,600.25 against £26,946.00 due — an over-deduction of £5,654.25 that is reclaimed rather than lost.

Rates, thresholds and allowances

The cash cap on tax-free lump sums is deliberately absent from this table, because it is absent from the rules files. Only the rate is modelled.

Sources

• gov.uk — Tax when you get a pensionThat part of a lump sum is tax-free and the rest is taxed as income, and that there are allowances limiting the tax-free part — the cap this software does not model.
• gov.uk — Claim back tax on a pension you have paid too much onThe emergency code on a first flexible withdrawal, and the routes by which an over-deduction is reclaimed. Cited for the panel that explains why the first payslip will not match this page.
• gov.uk — Tax on your private pension contributions: annual allowanceThe money purchase annual allowance triggered by taking taxable income flexibly, and that carry forward cannot be used against it.
• gov.uk — Income tax rates and allowances: current and pastThe personal allowance and its taper, which is what makes a single large withdrawal so much more expensive than several smaller ones.
• gov.uk — Pension schemes rates and allowancesThe annual allowance and the money purchase annual allowance.

Six things this calculation does not model, stated here rather than buried

• The cash cap on tax-free lump sums. The rate is modelled; the lifetime limit on tax-free cash is not held in this software at all. For anybody with large pension savings, or who has taken tax-free cash before, the tax-free figure shown may be too large and the tax correspondingly too small — the direction that produces an unexpected bill.
• Future years’ rules, and changing other income. Every row of the spread table uses the selected year’s figures and the same other income each year.
• Investment growth of any kind. The money left in the pension is not projected forward, so the spread table is a tax comparison and not a whole answer.
• Defined benefit lump sums. These are bought by giving up pension income at a commutation rate the scheme sets, which is not a tax figure and is not modelled. Nor are small pot lump sums, trivial commutation, or several withdrawals in one year interacting.
• Inheritance tax. From 6 April 2027 most unused pension funds come into charge for inheritance tax, which materially changes the comparison between leaving money in a pension and taking it out. That is outside every tax year offered here and no figure reflects it.
• Everything that is not income tax. Pension income bears no National Insurance, so there is none to show — but there is also no student loan repayment, no tax code adjustment, no High Income Child Benefit Charge, and no assessment of what a lump sum sitting in a bank account does to means-tested benefits.