Budget May Aim for Taxing a Quarter of Tax-Exempt Pension Lump Sums

In recent times, there has been a flurry of rumours suggesting that the Chancellor may be considering a cap on the amount of tax-free cash that can be taken from a pension. This news has sparked concerns among savers, who are questioning the future of their retirement plans.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, advises against rushing to take tax-free cash due to these rumours. She warns that taking tax-free cash and reinvesting it back into a Sipp could result in falling foul of strict pension recycling rules and a substantial tax charge.

The 25% tax-free lump sum is a key benefit of pensions, especially since pension freedoms allow it to be taken as a lump sum while leaving the rest of the pension pot invested. Gary Smith, senior financial planning partner at Evelyn Partners, emphasises this point, stating that the 25% tax-free cash is a key benefit of pensions.

For many savers, the 25% tax-free lump sum is used to pay off the mortgage or other expenses, and reducing it could throw retirement plans into disarray. If you have fixed protection relating to a previous, more generous lifetime allowance level, your higher 25% lump sum figure can apply.

However, not withdrawing the whole lump sum out at once can provide more tax-free cash available to take in the longer run if the pot grows. Over-55s can take 25% of their defined contribution pension pot tax-free upfront or withdraw it gradually in chunks.

Defined contribution pensions take sums from both employers and employees and invest them to provide a pot of money at retirement. Defined benefit salary-related pensions, on the other hand, provide a guaranteed income after retirement for the rest of life.

The options for a 25% lump sum from defined benefit pensions vary according to the generosity of the terms and conditions of the scheme. Withdrawing up to 25% of a pension pot is a popular tax-free perk at retirement, but fears of tightened rules were not realized last year.

Another complicating factor is the Government's plan to levy inheritance tax on pensions from April 2027. This could lead some savers to reinvest in offshore bonds. For savers who will be older than 75 by April 2027, unspent pension assets could also be subject to income tax as the beneficiary draws on them.

The Chancellor is considering a cap on pension tax-free lump sums as a cash-raising measure for the Autumn Budget. If implemented, this could put a big dent in pension freedoms and make savers feel like the goalposts have been moved. The risks of unnecessarily withdrawing the tax exemption lump sum include potential demands for back taxes, the imposition of high interest on unpaid amounts, and possible legal disputes. Incorrect or unnecessary withdrawal can also lead to financial and administrative burdens for taxpayers.

As always, it is crucial for savers to stay informed and seek professional advice when making decisions about their pensions. The situation is fluid, and changes to pension rules can have significant impacts on retirement plans. Keep a close eye on announcements from the Government and consult with a financial advisor to ensure you are making the best decisions for your future.