Will Labour end the 25% tax-free pension lump sum and should I take mine now to protect it?

Is there any advice that you could offer to mitigate against the potential pension tax increases please?

In particular, if the 25 per cent tax-free allowance is removed, would you advise on starting to plan to take that 25 per cent now?

If they change pension taxation, how much notice will we get to make changes?

SCROLL DOWN TO FIND OUT HOW TO ASK STEVE YOUR PENSION QUESTION 

Steve Webb replies: My mailbag has been bulging this week with question about potential changes which the new Labour Government might implement with respect to pension tax relief and to the state pension.

To be honest, I would be quite surprised if the new Government had yet come to a conclusion on most of these issues, so any reply on my part will inevitably be somewhat speculative.

But hopefully I can set out a few things which would be in the Government’s mind as they consider any changes, and also set out what your options might be.

As you know, in general it is possible to take 25 per cent of a ‘pot of money’ pension in the form of a tax-free lump sum.

It is also often possible to take tax-free cash as part of a traditional final salary pension scheme.

In legislation these are often referred to as ‘pension commencement lump sums’ (PCLS) but for brevity I will simply talk about ‘tax-free cash’.

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The ability to take tax-free cash from a pension is one of the few features of the pension tax system which people both know about and value. So it would be a brave politician who made major changes to this part of the system.

During a radio show in the election campaign, now Prime Minister Keir Starmer did suggest there would be a change, but Labour immediately admitted he had commented in error.

As long ago as the 1980s the former Conservative Chancellor, the late Nigel Lawson, famously said that he had considered changes to the ‘much loved but anomalous’ tax-free lump sum, but had decided against.

Because huge numbers of people are expecting to get tax-free cash from their pensions (including ten million people newly enrolled into workplace pensions since 2012), the political outcry if this right was abolished overnight would be enormous.

I therefore think outright abolition is exceptionally unlikely.

Lifetime limit for tax-free pension cash

There are, however, ways in which more limited changes could be made. The most obvious would be to look at the lifetime limit for tax-free cash. Since April 2023, this has been set at the very precise figure of £268,275.

This is simply 25 per cent of the (now-abolished) Lifetime Allowance of £1,073,100.

At the very least I would expect this figure to be frozen each year, meaning it will gradually bite on more people over time.

But one possibility would be for a new Chancellor to cut the limit – perhaps to £200,000 or £150,000.

This would still be way above the lifetime tax-free cash that most people could dream of getting, and so the political cost might be quite low.

With any such change, one key question would be what ‘transitional’ arrangements were put in place for those who might be unfairly affected.

A possible transitional measure would be to say that those who were already going to exceed the new limit based on pension saving they had already done would still be able to get full tax free cash up to the old limit, but that no further rights to tax-free cash could be accrued in this case.

This would be pretty messy to implement, but it wouldn’t be the first time a Government thought that complexity was a price worth paying for the extra revenue they could expect from capping tax relief.

Whilst I cannot give you personalised advice as to how you might respond to this possibility, I can say that it seems highly unlikely that any such change would apply retrospectively.

To be more precise, if someone had already taken tax free cash in excess of the new (lower) limit, I wouldn’t expect them to get a retrospective tax bill.

I would also be surprised if there was any penalty for those who accessed their tax-free cash post-election but before any Government announcement.

But I would stress that this is only my best guess and you should take independent financial advice before making any major decisions about your pensions.

It is however possible (as I pointed out in my previous column on the Lifetime Allowance) that the Government could stand up and announce that although any change to the limits would not take place until a date in the future, any entitlements to a lump sum built up from now on would not qualify for any transitional protection.

This means that although changes usually only take place at the start of a financial year, it remains possible that a Government announcement could fire the ‘starting gun’ on a change with more-or-less immediate effect.

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