- Labour’s pension tax relief changes remain speculative
- Tax-free cash from pensions unlikely to change
- Possible lifetime limit adjustment on tax-free cash
Steve Webb responds: This week, my mailbox has been overflowing with questions regarding prospective changes that the next Labour Government may make to pension tax relief and the state pension.
If the new government has yet to reach a decided topic, any response from me will be pretty speculative.
But I can outline some of the things that the government will consider as it examines any adjustments and your alternatives.
25% of a ‘pot of money’ pension can be taken as a tax-free lump payment.
It is also frequently possible to withdraw tax-free funds from a regular final salary pension plan.
In legislation, these are commonly referred to as ‘pension commencement lump sums’ (PCLS), but for brevity, I will refer to them as ‘tax-free cash’.
The option to withdraw tax-free income from a pension is one of the few aspects of the pension tax system that people are both aware of and appreciate. It would take a daring politician to change this aspect of the system significantly.
During the election campaign, now-Prime Minister Keir Starmer hinted at a change on a radio appearance, but Labour quickly realized he had made a mistake.
The late Nigel Lawson, former Conservative Chancellor, notably stated in the 1980s that he contemplated adjustments to the ‘ much liked but anomalous’ tax-free lump amount but opted against them.
Because many individuals anticipate receiving tax-free cash from their pensions (including ten million people who have joined employer pensions since 2012), the political outcry if this privilege were removed overnight would be significant.
Total abolition is extremely unlikely.
Lifetime limit on tax-free pension cash.
However, there are techniques for making more limited adjustments. The most obvious would be to consider the lifetime limit for tax-free cash, which has been set at a precise £268,275 since April 2023.
This is merely 25% of the (now-abolished) Lifetime Allowance of £1,073,100.
At the very least, this figure will remain constant year after year, implying that it will gradually affect more people over time.
However, a new Chancellor might reduce the ceiling to £200,000 or £150,000.
This is still far more than most individuals could hope for regarding lifelong tax-free income. Thus, the political cost may be modest.
One critical consideration in any such adjustment would be whether ‘transitional’ preparations were made for individuals who could be disproportionately affected.
A conceivable transitional remedy would be to state that persons who were already going to exceed the new limit due to pension savings would be permitted to receive total tax-free cash up to the previous level. Still, no more rights to tax-free cash may be acquired in this situation.
This would be difficult to implement, but it would not be the first time a government decided that complexity was worth paying for the extra money they could expect from capping tax relief.
While I cannot offer you personalized guidance on responding to this possibility, it appears improbable that any such change would apply retrospectively.
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If someone has already taken tax-free cash over the new (lower) limit, I would not anticipate them to get a retrospective tax bill.
I’d also be astonished if there was a penalty for those who used their tax-free funds after the election but before any government declaration.
However, this is merely my best judgment, and you should get independent financial counsel before making any significant decisions concerning your pension.
However, as I mentioned in my previous column on the Lifetime Allowance, the government could announce that, while any changes to the limits would not take effect until later, any entitlements to a lump sum built up from now on would not be eligible for any transitional protection.
This means that, while changes are typically implemented at the start of a fiscal year, a government announcement could serve as the starting gun for a change that has a more-or-less immediate effect.
