The Significant £1m Pension Issue: The Potential Denial of 25% Tax-Exempt Cash

In a significant shift for pension savers, changes to the rules surrounding tax-free cash and the lifetime allowance have been introduced, affecting those with defined benefit pension schemes in particular.

The Lifetime Allowance, the amount you can put into workplace pensions and Self-Invested Personal Pensions (Sipps) without incurring a tax penalty, was reformed in April. The former Chancellor, Jeremy Hunt, announced the scrapping of the £1,073,100 lifetime allowance in the March Budget of last year.

One of the key changes is the maximum tax-free cash that can be withdrawn from a pension pot, now set at £268,275. However, it's important to note that the value of this tax-free lump sum decreases over time due to inflation, dropping to £199,622 after 10 years.

Savers with defined benefit pension schemes may need to consider more complex planning to protect their tax-free cash amount. Withdrawing money from a pension will lose its advantageous inheritance tax status, making it a crucial consideration.

The wealth manager Quilter has labelled these changes a "stealth tax" and warns of major consequences for those with significant pension wealth. Roddy Munro, head of tax and pensions at Quilter, emphasises that the freezing of the amount of tax-free cash will affect those with large pension funds. Alice Haine, personal finance analyst at Bestinvest, adds that giving up tax-free investment growth and making the money liable for inheritance tax are additional considerations when taking tax-free cash early.

Some savers may choose to crystallize their pension earlier and invest in products like Individual Savings Accounts (ISAs) and insurance bonds to protect and grow their tax-free cash. Triggering the money purchase annual allowance (MPAA) reduces the maximum annual contribution to pensions to £10,000 a year.

Chancellor Rachel Reeves could reveal further changes to pensions in the autumn Budget on 30 October. It's essential for savers with defined benefit pension schemes to take professional advice to protect their tax-free cash amount, as these changes can have significant implications for their retirement planning.

Insurance bonds can help control taxes, simplify tax reporting, and provide inheritance tax planning benefits. They can be a valuable tool for those looking to manage their tax liabilities and plan for the future.

It's important for savers to stay informed about these changes and seek advice from financial professionals to ensure they are making the best decisions for their retirement plans.