Changes to the ‘tax-free lump sum’ you can withdraw from your pension

There has always been a strong argument in favour of saving for retirement via a company or personal pension, mainly due to the substantial tax-relief that that pensions attract, especially for higher-rate tax payers. However, set against this are the facts that:

1. there is a lot of money invested in pensions

2. the UK Government is still trying to find ways of balancing its books following the credit crisis and subsequent recession.

Over the last decade there have been a number of changes to pensions legislation that have resulted in both the lifetime limits and the annual limits on pension savings being reduced quite significantly. This trend may well continue. However, until now, one particular area of pension benefits has not come under Government scrutiny; the ‘tax-free lump sum’ that you can withdraw from your pension pot.

At the moment, from the age of 55 onwards, if you have a pension, you are allowed to withdraw 25% of its value in cash, tax-free. If you choose to draw more money from your pension as income after that, then the income is taxed, effectively meaning that saving in a pension is a way of deferring payment of tax, rather than avoiding it all together. However, the 25% lump sum withdrawal is never taxed, so, on balance, it is usually more tax-efficient to save money in a pension than elsewhere (make sure that you ask the advice of a qualified pensions expert to make sure that this applies to you.)

Pension experts like Ian Cowie and Dr Ros Altmann are saying that the 25% figure might not last for long, given the Government’s need to raise more money. The first sign that this benefit might be under review was back in 2006 when the terminology was changed from ‘tax-free cash’ to ‘pension commencement lump sum’ – i.e. no mention of ‘tax-free’. Now the the Treasury is apparently “actively considering” capping the amount you can take tax-free. Dr Altman has been quoted that limiting the maximum amount you can take to £36,000 would bring in an extra £2 billion revenue for the State.

No figures have yet been discussed in public by the Government, but bringing in a maximum amount of £36,000 would not affect most people, since the average pension fund is worth less than £50,000 anyway. But would it affect you? If you are 55 already and have a pension pot that is significantly above the national average, you might want to consider taking your 25% ‘pension commencement lump sum’ sooner rather than later, in case there is a change in the legislation.

Next steps

If, having read this blog, you’re not sure whether such a change in the ‘tax-free lump sum’ will affect you, then please call Marchwood IFA now and ask us to review your pension arrangements. We can help you make the right decisions to help you achieve your retirement goals.