RACHEL Reeves is reportedly considering cutting the tax-free pension lump sum as she tries to boost public finances.
The chancellor is looking at it among a list of options ahead of her Budget this autumn, according to The Telegraph.
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Reeves faces difficult choices ahead as she needs to fill an estimated £50billion black hole in public finances.
Industry insiders told the newspaper there was widespread speculation she could cut the maximum amount people can withdraw from their pension without paying tax.
Currently you can withdraw up to 25% of your pot tax-free when you reach the age of 55.
The amount is capped at £268,000, but the proposals could see this amount cut.
Officials estimate cutting the cap could raise more than £2billion a year.
It’s worth noting that this is among a range of measures being considered and nothing is set in stone yet.
One Whitehall official said the chancellor was not prioritising pension reforms and they thought it was “unlikely”.
But it’s thought the measure is on the table and the chancellor could be forced to act given the scale of the country’s economic problems.
She has already ruled out breaking Labour’s manifesto promise not to raise taxes for working people.
This means income tax, VAT or employee National Insurance contributions should all be safe from tax rises.
Therefore pension relief is one of the few options left for her to raise significant funds.
Pensions minister Torsten Bell has previously advocated cutting the tax-free lump sum limit to just £40,000.
When he was head of the Resolution Foundation think tank, he said the current tax-free allowance was “very generous, very regressive, and a strange incentive not to stagger your retirement income”.
“Capping the tax-free lump sum at £40,000 would raise £2billion a year while leaving three-quarters of future pensioners unaffected,” he said at the time.
Last year, the Institute for Fiscal Studies (IFS) and Fabian Society think tanks proposed cutting the limit to a more generous £100,000.
Treasury officials had asked a top pension provider to assess the impact of reducing the limit to £100,000 ahead of last year’s budget.
But Reeves opted against the move and instead chose to increase National Insurance contributions for employers.
The Sun has contacted the Treasury for comment.
Tom Selby, director of public policy at investment platform AJ Bell, said: “Cutting pensions tax-free cash is pretty unappealing, even for a chancellor as cash strapped as Rachel Reeves, because it will raise very little money in the short-term.”
He said the Government would need to protect people who have built up their tax-free pension savings up to the current limit, so any savings for the public purse would only be seen a long way into the future.
He also warned that allowing the speculation to continue could risk undermining people’s plans to save for retirement.
What is tax-free pension cash and when can I take it?
When you get income from pensions – both the state pension and private pensions – you normally have to pay income tax on anything over the personal allowance, which is currently £12,570 per year.
But a special privilege of pensions is you can take some of the money free of income tax, which is a key reason for saving into pensions in the first place.
If you have private pensions or workplace pensions – as most employed people now do – you can take up to 25% of the total value of all your pension pots as a tax-free lump sum.
You are currently allowed to access this money from age 55 onwards, but this will rise to 57 in April 2028.
Experts have urged people not to rush into any financial decisions based on the speculation.
Ian Cook, chartered financial planner at Quilter Cheviot, said: “The concept of reducing the tax-free cash allowance is just one of several being tested in the past few weeks, and it’s important to remember that none of these proposals are set in stone.
“The best advice right now is to stay informed, speak to a qualified adviser if you’re unsure, and avoid making any irreversible decisions based on speculation.
“Financial planning should be based on certainty, not conjecture and that means waiting for clear, official guidance before taking action.”
What other options are on the table?
The chancellor will be eyeing up a number of options ahead of the Budget and speculation is rife.
She is thought to be considering inheritance tax changes among the options.
This includes stopping parents from making unlimited tax-free gifts to kids by capping the value of gifts that someone can pass on to loved ones.
Currently, you can give away unlimited amounts of money and assets to friends or family members without paying inheritance tax, as long as you do so seven years before you die.
Reeves is also reportedly considering a raid on the sale of high-value homes.
This would mean charging capital gains tax on the sale of family homes worth more than £1.5million.
Another option is replacing the current stamp duty thresholds with a new property tax.
The Guardian reported earlier this week the chancellor is considering a new levy of 0.54% per year on houses over £500,000.
Meanwhile, any home worth more than £1million would pay 0.81% on the proportion of its value over the threshold.
This would replace the current stamp duty thresholds, which are tiered depending on the value of your home.
Officials are also said to be looking at whether to replace council tax with a local property tax.
This would mean a total overhaul of the current council tax system, where an annual fee is paid to the local council to fund services such as road upkeep and state schools.
Pros and cons of taking out your pension tax-free lump sum
Some savers may want to take out their tax-free lump sum to pay off other significant debts or clear their mortgage.
Others might want to buy a holiday home, gift the money to children or grandchildren, or make house renovations.
It can be wise to clear mortgages and debts while you’re in your mid-50s.
But there’s lots to consider before you take money out of your pension pot.
For example, if you’re spending the money on things that are nice to have then you could be left short when you retire.
Plus you could lose out long-term compared with if you left the money in your pension pot.
Taking the cash out and putting it into a bank account could mean it loses value over time because of inflation.
If you keep it in your pension for longer, it can grow tax-free.
You can also buy a bigger annuity – the amount of income you’re guaranteed to receive each year in retirement – if you haven’t already taken money out of your pension pot.
If you have a defined benefit pension, where you get a guaranteed income for life, then often you have to give up some regular pension income in exchange for the lump sum.
You should also consider the impact of inheritance tax (IHT).
While money held in a pension can be passed on free of IHT – and potentially income tax-free if you die before age 75 – money held outside your pension could form part of your estate and be taxed at 40%.
Mike Ambery, retirement savings director at Standard Life, said: “Pensions are long-term savings vehicles, and decisions about them should be made with a long-term perspective.
“Acting on speculation can lead to unintended consequences – such as missing out on future investment growth or making choices that don’t align with your retirement goals.”
