I have read several articles regarding possible changes to pensions in the forthcoming autumn Budget.
If there are changes to how much someone can take from their pension as a tax-free lump sum, will they take effect immediately, or at the start of the next tax year, or do they need to be agreed through parliament?
Ask Steve Webb your question. Email pensionquestions@thisismoney.co.uk
Steve Webb replies: The constant uncertainty about potential Budget changes to pension tax relief certainly makes planning for your retirement more difficult.
As a general principle, it’s usually best to avoid making life-changing decisions based on speculation, but I entirely understand the anxiety about suddenly finding out that a carefully constructed retirement plan has suddenly been upended.
At the moment, someone can take 25 per cent of their pension pot as a tax-free lump sum once they hit the age of 55. The maximum amount that can be taken tax-free is £268,275.
Let’s consider the options which the Chancellor might consider and when they might take effect.
As always, nothing in this column represents financial advice, and my personal views here are for information only.
Steve Webb: Scroll down to find out how to ask him YOUR pension question
Will tax-free lump sums be abolished?
The most extreme Budget option would be to simply do away with the ability to take any money tax-free out of your pension.
But I think this is incredibly unlikely.
Not only could this wreck the retirement plans of people close to pension age, it would create millions of losers amongst the wider workforce.
In particular, automatic enrolment into workplace pensions has brought another ten million people into workplace pension savings, and all of these will be expecting to benefit from the potential for a tax-free lump sum.
Taking this away would anger so many people that it seems inconceivable that it could happen.
Will tax-free cash limit be cut?
A more plausible scenario would be where the existing lifetime limit of £268,275 on tax-free lump sums was significantly lowered – perhaps to £100,000 or even lower.
Whilst this is more likely, and could be regarded as only affecting those with the largest pension pots, my view is that this remains unlikely.
There are several reasons why the Chancellor might hold back from cutting tax free cash in this way.
First, it would create uproar amongst those who were close to retirement and had planned their finances around having access to a tax-free lump sum. For example, what would people do if they had planned to use their lump sum to pay off a mortgage but now had to pay a chunk of tax on it?
Most people would feel that a change like this was like ‘moving the goalposts’ and was fundamentally unfair.
Second, if there were such a change the Chancellor would need to introduce some form of ‘transitional protection’ to cushion the impact on anyone close to retirement. This is what happened each time the old Lifetime Allowance was cut in 2012, 2014 and 2016.
But there are problems for the Government with introducing transitional protection of this sort.
The first problem is that there is a risk of falling foul of age discrimination rules. Other pension changes (to public sector pensions) had age-based protections built in, only to be ruled illegal because they discriminated on the basis of age.
In addition, a comprehensive system of transitional protection means few losers early on and therefore little money for the government.
A change which creates a lot of political fuss but little extra money before the election is not a great package for the Government.
There is a further challenge for a Labour government in cutting tax-free lump sums. Those with long service in public sector schemes can build up a significant lump sums even if they have not been top earners.
Hitting long serving public servants might be especially challenging for a Labour government and could inflame the already sensitive state of industrial relations in parts of the public sector.
How quickly might changes be introduced?
For some Budget changes, it is possible to act almost immediately.
In the days when petrol prices used to go up every year at the Budget it was common for Chancellors to announce that the change would take effect at 6pm on the same day.
It is much harder to do something like this for pensions.
Although Governments generally have no problem getting Budget measures through the House of Commons, especially if they have a large majority, there are huge practical barriers.
Simply implementing a change like this could take years. A system of transitional protection would almost certainly be needed and this would need to be carefully designed and consulted on.
In addition, computer systems of employers and pension schemes and pension providers would all need to be changed to reflect the new rules, and lots of websites and letters would need to be changed to reflect the changes.
It is quite possible that even implementing a change of this nature would be hard before 2027/28.
It is possible that the Chancellor could say that the changes will be implemented in 2027 but that ‘anti-forestalling’ measures will be put in place to avoid a mad scramble to get tax-free cash out before the change.
This would need to be carefully designed but it could, for example, say that any protections of existing lump sums applied only to money paid in up to Budget day, and not to money added between Budget Day and the implementation of the change.
But this creates even more complexity in an already complex system.
In short, whilst it’s theoretically possible that the Chancellor could drastically scale back tax-free pension lump sums, there are good reasons why successive Chancellors, having looked at this, have decided against.
It would be a shock if the present Chancellor came to a different conclusion.
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