Pension Tax-Free Cash

There are lots of rumours about the pension tax free lump sum changes in the press and I wanted to write and clarify what we know as facts. 

Keir Starmer inadvertently suggested that the option to withdraw 25% of your pension as a tax-free lump sum might soon be discontinued.  You can listen to that here (around the 16-minute mark).

In response, Labour clarified that they are firmly committed to maintaining the current system. Labour representatives confirmed that the tax-free lump sum will not be eliminated.

Below is an excerpt from the FT article. Click here to read the the full article.

Labour quickly tried to defuse the issue. “The ability to withdraw 25 per cent of your pension as a tax-free lump sum is a permanent feature of the tax system and Labour are not planning to change this,” a spokesman said.

Asked whether Labour was making a solid promise not to change the current system – as opposed to simply having “no plans” – a spokesman said: “It’s a firm commitment.”
Source: FT

The ability to withdraw 25% of your pension tax-free is one of the most attractive and generous features of the UK pension system, encouraging many to save into pensions rather than other investment options. Eliminating this benefit would be a significant change and likely unpopular with millions of savers, making its abolition improbable.

However, it remains uncertain whether the government might consider reducing the tax-free amount. The current cap of £268,275 is not set to increase with inflation, which means that in real terms, the tax-free cash available to those with larger pension pots will decrease over time, even if the policy itself remains unchanged.

Also it’s important to remember, changing the tax free cash amount impacts everyone, not just personal pension holders. Think of the hundreds of thousands of civil servants, police, army that it will also effect, many of whom plan their retirement on very generous/large tax free cash payments.

Taking the tax free cash early, unless you have reason to spend or gift the money, impacts the tax free compound growth it’s enjoying and tax efficiency of the money.  Bringing the tax-free lump sum into your estate, most likely will, make it liable to 40% inheritance tax.

We believe Rachel Reeves is being irresponsible allowing these rumours and this uncertainty to circulate, it looks like we will find out on 30 October, but in the meantime Lexington’s view is that unless you plan to access your tax-free cash in the next 12 months, Keir’s statement in the FT is reason to believe it won’t be effected and no action is necessary.