Is the Government about to scrap the tax-free pension lump sum?

Investing and pensions

Updated on 06 April 2016 | 10 Comments

The option of taking a tax-free lump sums from your pension could soon disappear, according to the former Pensions Minister.

The Government may be about to scrap your ability to take a large chunk of your pension, tax free.

Steve Webb, the former pensions minister, said that the tax-free lump sum could be scrapped if the Government’s proposed Pension ISAs go ahead.

Such a change could save the Treasury as much as £4 billion a year.

Webb criticised the proposal, saying that the tax-free lump sum is one of the best-understood parts of the current pension tax system. He also warned of pension savings being less attractive in the long run, as the lump sum helps people to pay off mortgages or help their children pay for housing deposits.

What is the current system?

At the moment, when you reach retirement age you can take out 25% of your pension pot absolutely tax free. You can use that cash however you wish. Traditionally you would then use the rest to buy an annuity, or move into a drawdown plan, though with the implementation of the pension freedoms last year pensioners now have a host of options.

If you are part of a defined benefit, or final salary, pension scheme you can still take advantage of the tax-free lump sum. The 25% is calculated based on what your promised retirement income is.

Tackling pensions

The Government wants to eliminate the deficit, and reducing the huge tax advantages on offer with pensions is clearly proving an attractive option.

Speculation is already rife that George Osborne will change the tax relief on offer when you make a contribution to your pension. The current system grants you tax relief based on your Income Tax bracket. So if you are a basic rate taxpayer, your contributions are topped up by 20%, while higher and additional rate taxpayers see their contributions increased by 40% and 45% respectively.

However, it appears likely that the Government will implement a flat rate of tax relief at the Budget next month, which would dent the attractiveness of pensions but save billions. 

For more read Pension tax relief to be slashed in 2016 Budget.

 

Get clued up on pensions:

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