Take the income, not the quarter: the sum your adviser has not run

Figures relate to tax year 2025-26 (UK) · 2025 (US)

There are two ways to take money out of a British pension, and for almost everybody in the country the choice is obvious. Take the quarter tax free first, then draw income afterwards.

Reverse that order and a British pensioner pays more tax. Reverse it as an American and you frequently pay less, sometimes by tens of thousands.

The reason is that the tax free lump sum generates no British tax at all, so nothing exists to credit against the American charge that follows. Income does generate British tax, and that tax does the work.

Key takeaways

• Britain exempts the pension commencement lump sum within an allowance.
• America taxes it as ordinary pension income.
• No British tax arises, so no foreign tax credit exists.
• Your own past contributions can reduce the taxable amount.
• Taking income instead keeps the credit mechanism working.
• The year you take it decides the rate you pay on it.
• Treaty positions need disclosing rather than assuming.

Is taking income instead better?

For many Americans, yes, and the arithmetic is stark. Drawdown income attracts British tax, which then generates a credit against the American charge on the same money. The credit usually wipes out the American bill entirely.

So the withdrawal that looks expensive in Britain is often the cheaper one for you.

In our practice that reversal surprises almost every client we explain it to.

Lump sum against drawdown income

How much does the timing matter?

Enormously, because a lump sum lands as ordinary income in a single year and pushes you up the rate bands. Taking it in a year with no salary costs far less than taking it in your final working year. The difference often runs to five figures.

Retiring in March and drawing in the following January splits them across two years.

That single decision is usually worth more than everything else combined.

Can you split it across years?

You can, through phased withdrawals that take a quarter of each crystallised slice rather than a quarter of the whole fund. Britain allows this freely and it spreads the American income across several tax years. Each slice still faces the same treatment.

Phasing turns one large charge into several smaller ones at lower rates.

Most providers support it without difficulty.

How big is the difference in practice?

On a £100,000 payment the gap between the worst case and a planned one regularly reaches £20,000. Taking it alongside a full salary, with no basis evidence, produces the worst case. Taking it in a clear year, phased, with contribution records, produces the best.

Neither outcome depends on anything clever. Both depend on decisions made a year or two ahead.

That gap is why this single question is worth professional time.

A worked example

Take an illustrative example. An American in Oxford reaches 60 in 2025 with a personal pension worth £400,000.

She takes £100,000 as her tax free lump sum. HMRC charges nothing and she has no British return entry to make.

America treats the whole £100,000 as pension income for that year, less whatever basis she can prove. At her marginal rate the bill reaches tens of thousands of dollars.

Because Britain charged nothing, no credit offsets any of it. Her British neighbour with the same pension pays nothing at all.

What is basis recovery?

Recognition that part of your pension came from money America already taxed, which should not face tax twice. Contributions you made personally from taxed salary can create basis. Employer contributions and investment growth cannot.

Basis reduces the taxable portion of any withdrawal, including a lump sum.

Proving it needs contribution records going back decades.

Can you actually prove basis?

That is the practical difficulty. A pension that ran for thirty years needs thirty years of payslips or scheme statements to establish what you personally paid in. Providers rarely keep records that far back and employers disappear.

Start gathering the evidence years before you intend to draw anything.

Without it, America taxes the whole payment.

Does treaty relief on contributions matter here?

It works against you on this point, which feels unfair. Contributions sheltered from American tax under the treaty generate no basis, because America never taxed that money. The relief you claimed earlier reduces the relief available later.

Our guide to employer pension contributions and US tax covers the earlier relief.

The two sit at opposite ends of the same pension.

Is there any planning that genuinely removes it?

Honestly, no. Nothing available to an ordinary pension holder makes the payment disappear, and anything promising otherwise deserves scepticism. Instead the realistic levers are timing, phasing, basis evidence and choosing income over capital.

Even so, those four together routinely cut the charge by half.

That is a planning result rather than a loophole.

What is the tax free lump sum?

The slice of a British pension you can take without paying income tax, normally a quarter of the fund. For 2025-26 the lump sum allowance caps it at £268,275 across all your pensions. According to GOV.UK guidance on private pensions, anything above that allowance becomes taxable in Britain.

Most people take it as a single payment at retirement.

Others take it in slices alongside drawdown, which changes nothing about the American analysis.

Why does America tax it?

Because the treaty hands the United States the right to tax its own citizens almost regardless of what the rest of the treaty says. That provision, the saving clause, overrides the article that would otherwise leave a lump sum taxable only in Britain. So the exemption protects British residents and not American ones.

Our guide to the treaty saving clause explains how far it reaches.

A non-American spouse drawing the identical payment keeps it entirely.

Should you take it at all?

Sometimes the answer is simply no. Where you need capital for a specific purpose, the charge is a cost of getting it. Where you merely want income, drawdown achieves the same thing with the credit mechanism intact.

Leaving money inside the pension also keeps it growing without American tax on the growth.

That protection is worth preserving where you can.

What happens to the rest of the fund?

Whatever stays behind keeps growing without American tax on the growth, which is the treaty protection working as intended. Therefore every pound you leave inside the wrapper is a pound still sheltered. Taking the maximum early gives that protection up.

Crucially, that shelter has no equivalent outside a pension for an American in Britain.

In short, the fund is the most tax efficient thing most clients own.

Does it apply to a final salary scheme?

Yes, and the mechanics differ slightly. A defined benefit scheme pays a lump sum by giving up part of the annual pension, at a commutation rate the scheme sets. The amount received still counts as American income in the year of payment.

Our guide to the teachers pension and US tax works through a public sector scheme.

Commuting at a poor rate hurts twice over for an American.

What about small pots?

Britain lets you take small pensions under £10,000 as a one off payment, a quarter of it tax free. America applies the usual treatment to the whole amount. Several small pots in one year can add up to a meaningful charge.

Spreading them across tax years costs nothing and saves real money.

Providers rarely mention this, because it makes no British difference.

Do annuities work differently?

Not for this purpose. Buying an annuity with the remaining fund simply converts it into income, and that income behaves like drawdown on both sides. As a result the credit mechanism works normally against it.

By contrast the opening payment keeps its own treatment whatever you do next.

Equally, the annuity decision should turn on retirement needs rather than tax.

Does the investment surcharge apply?

No, which is one genuine piece of good news. Pension distributions sit outside the net investment income charge entirely. A large withdrawal can still push other investment income over the threshold indirectly.

Our guide to the net investment income tax explains the thresholds.

So the headline rate is the income tax rate alone.

What about taking it before moving to America?

Nationality rather than residence drives this, so moving changes nothing for a citizen. An American in Britain and an American in Boston face the same charge on a British lump sum. Only a non-citizen gains from the timing of a move.

Green card holders should look carefully at the dates.

Our guide to moving back to the US covers the wider checklist.

Does renouncing before drawing help?

In principle yes, because a former citizen falls outside the saving clause and the treaty exemption applies properly. In practice the expatriation rules may reach the pension on the way out. The sums rarely work for that reason alone.

Our guide to planning an expatriation date covers the sequencing.

Nobody should renounce over a single pension decision.

Does transferring the pension help?

Moving a pension overseas triggers its own British charge and solves nothing on the American side. The overseas transfer charge applies in many cases at twenty five per cent. Transferring to escape this problem reliably makes it worse.

Our guide to the overseas transfer charge covers when it applies.

Leaving the pension where it sits is almost always right.

Does it affect your UK tax code?

Usually not, because a payment within the allowance never enters the British system as income. However, taking anything above the allowance does, and providers often apply an emergency code to the taxable part. In that case you reclaim the excess afterwards.

Meanwhile the American charge runs on the full amount either way.

So a British refund and an American bill can arrive in the same month.

How does the exchange rate affect it?

America measures the payment in dollars on the date you receive it. A weak pound reduces the dollar income and a strong one inflates it. Nobody should time a retirement around currency, though the effect is real.

Record the rate you used alongside the payment advice.

Use the same convention you apply to the rest of your return.

What does your state say?

Several states tax pension income with no credit for foreign tax and no equivalent exemption. Anybody still tied to a state should check before drawing anything substantial. Breaking residence properly beforehand is worth real money here.

Our guide to state tax for expats covers the problem states.

Most long term expatriates have nothing to worry about.

Do you disclose a treaty position?

Where you take a position that the treaty changes the default treatment, a disclosure form accompanies the return. Claiming the lump sum is exempt would be exactly such a position. Most practitioners regard that claim as wrong given the saving clause.

Our guide to disclosing a treaty position covers the form.

Taking an aggressive position without disclosing it carries its own penalty.

Does your spouse inherit the problem?

Only if they are American themselves. A British widow or widower drawing a survivor pension faces no American charge at all. However, an American survivor inherits the same treatment you had, including on any further payment.

Therefore couples with one American often leave the pension to the other.

Our guide to death in service benefits and US tax covers the wider position.

What if you already took one?

Report it for the year you received it and amend if the return has already gone in. Many people discover the issue afterwards, because nothing in Britain flags it. An amended return costs far less than an enquiry.

Our guide to amending a US return covers the mechanics.

Gather the basis evidence before amending rather than afterwards.

What if the pension is your only income?

Then the arithmetic improves considerably, because the American personal allowances absorb a slice of the payment before any rate applies. Somebody fully retired with no salary may pay very little. By contrast the same payment taken a year earlier, on top of a final salary, can cost thousands.

So the single most valuable step is simply waiting until the salary stops.

Even six months of patience can move the payment into a far cheaper year.

What records should you keep?

Keep every annual contribution record you can find, the payment advice for the lump sum itself, the exchange rate applied and any treaty disclosure filed. Together they fix both the income and the basis against it.

Ask your provider for a full contribution history before you retire, not after.

Keep everything permanently, because basis matters for the rest of the pension's life.

How to plan the withdrawal

1. Ask the provider for a complete contribution history.
2. Separate your own contributions from employer ones.
3. Model the American charge on the full amount.
4. Compare taking income instead of a lump sum.
5. Pick a tax year with the least other income.
6. Consider phasing the withdrawal across several years.
7. Check your state position before drawing anything.
8. Keep the payment advice and the rate you converted at.

Mistakes and penalties we see with a lump sum

The first is taking the quarter automatically because a British adviser suggested it. For an American it is the most expensive withdrawal available.

The second is drawing it in a final working year, stacking it on top of full salary.

The third is claiming treaty exemption without disclosure, which adds a penalty to a position that was probably wrong anyway.

The fourth is never gathering contribution records, which hands America the whole payment to tax.

How US UK Tax Accountants helps

We model the lump sum against drawdown before anybody signs a retirement form, because that comparison usually reverses the obvious answer. Then we pick the year that costs least.

Where a payment has already happened, we rebuild the basis evidence and amend properly. Our pensions service covers the whole retirement sequence.

If you are within five years of drawing a British pension, get in touch before you commit to anything.

Last reviewed 18 October 2026. This article is general information and not personal tax advice. Pension decisions are hard to reverse, so take advice on your own scheme.