Autumn Statement: Will pension tax free cash be axed?

Rumours continue to swirl about next month’s Budget from Chancellor Rachel Reeves. No surprise then that pensions have come under the media spotlight. Often a soft target for government tinkering there have been multiple changes over the years, including to the lifetime allowance and the annual allowance more recently. These are the limits governing how much you can accumulate across pensions without incurring a tax charge, and the maximum you can save each year for the purposes of tax relief.

With the Labour government committed to a wide review of the pensions and retirement landscape we can expect some tweaks to the rules ahead. Perhaps even some wide-ranging changes. Inevitably, this has led to questions and concerns surrounding the ongoing availability of the 25% tax-free cash lump sum that most savers can enjoy when they start drawing from their pot. Under current rules this can be done from the age of 55, rising to 57 by 2028.

Tax-free cash – also known more technically as a pension commencement lump sum – is a valuable and widely appreciated aspect of the pension system and a significant reason why saving into a pension is advantageous from a tax perspective. While income and withdrawals from defined contribution pensions such as SIPPs are usually subject to income tax, a quarter of the pot can typically be taken tax-free. There is also a maximum monetary amount for tax-free cash set at £268,275, which is 25% of the now-abolished lifetime allowance.

What might the government do to tax-free cash?

With a claimed £22bn black hole appearing in the nation’s finances, the government could look to water down this pension perk. For instance, it could reduce the percentage of the pot to say 20% or set a stricter limit on the monetary amount.

However, the government says it is keen to improve pension saving and retirement outcomes. With a wide-ranging pensions review being conducted by pensions minister Emma Reynolds, any knee-jerk move to radically restrict tax-free cash would seem to be at odds with a considered appraisal and the careful consideration of the role of the pensions system in retirement income adequacy.

There are important second-order consequences to be borne in mind with any policy change. Usually, there is a behavioural response and any move that makes pensions less attractive from a tax perspective risks dissuading long-term savings and tarnishing the image of pensions in the public consciousness.

The IFS recently warned many current workers are heading for “inadequate retirement incomes”, with between 30% and 40% of private sector employees likely to fall short of the level required for a minimum standard of living. Low asset returns and increases in life expectancy already make it hard for workers to build a sufficient pot to deliver a comfortable retirement. Combined with the disappearance of defined benefit schemes it means increasing numbers of people are moving into retirement with inadequate provision. Reducing the tax efficiency of pensions would only exacerbate the problem.

Any unexpected, radical shift in the pension rules also risks pulling the rug from under people who have made retirement plans using the current system in good faith. Most retirees rely on income outside the state pension, and they would end up being punished for making good decisions around financial self-reliance. There would also be specific cases of particularly poor outcomes, for instance, those relying on the value of a lump sum to pay off their mortgage upon retiring might suddenly face a shortfall.

The government needs to instil confidence in the pension system, both at present and in the future, and put it on a sustainable path to meet societal and economic goals. Substantive change that moves the goalposts and undermines trust should therefore be avoided. Overall, we believe it makes sense to leave pensions alone in the Budget, to promote stability, and to wrap such deliberations into the government’s longer-term strategy around retirement provision.

What can people do?

Changes affecting pensions in the Budget cannot be ruled out. In relation to tax-free cash, a reduction to the maximum monetary amount set at £268,275 would be a straightforward lever for the Chancellor to pull to target larger combined pots without altering the well-understood narrative around the general tax efficiency of pensions.

Limiting the tax-free lump sum to a greater degree would be hugely unpopular and undermine efforts to boost long-term investing, including in UK businesses – so it seems unlikely but ultimately, we can’t rule it out.

We emphasise that anyone potentially affected should not rush into a decision. Taking a lump sum from a pension is an irreversible process that involves moving money from a tax-efficient environment to, potentially, a non-tax-efficient one. This can have a significant impact on your retirement income later in life, so acting to pre-empt changes to pension rules could ultimately backfire.

It is also worth noting that it is not customary or indeed practical for significant changes to happen overnight. Pension companies would need due notification to reconfigure systems, and to impose any significant changes on people in the process of making potentially life-changing decisions about their retirement would be unpopular and inequitable. We therefore anticipate that any sweeping changes would be appropriately flagged in advance, so retirees and their advisers have time to plan for the ramifications.

Before acting you should seek professional financial advice or guidance on your options based on your individual circumstances. If this issue is on your mind, why not talk to one of our financial coaches.