Pensioners and retirement savers across the UK are facing a period of uncertainty as speculation grows over a possible sweeping tax reform targeting pension benefits. The government has confirmed that changes to pension taxation are under consideration, though no formal details have been released. This comes ahead of the Autumn Statement, where major financial measures are typically outlined.
While the exact scope of the proposals remains unclear, early reports suggest the longstanding tax-free pension lump sum may be affected. Financial experts have begun advising individuals to review their retirement strategies now, in anticipation of adjustments that could alter future withdrawal rules.
Alarm Raised Over Threat To Tax-Free Pension Lump Sum
For decades, pensioners in the UK have relied on the ability to withdraw up to 25% of their pension savings tax-free, a benefit that has become central to many retirement strategies. As it stands, this allowance is capped at £268,275, meaning no matter the size of one’s pension pot, the tax-free lump sum cannot exceed that amount. This cap remains in place despite the abolishment of the Lifetime Allowance.
According to Chris Ball, CEO at Hoxton Wealth, that rule may soon change.
“As things stand, you can take 25 per cent tax-free, from two different pensions. There may however be changes made to this rule in the Budget, with it being suggested that under Rachel Reeves, the 25 per cent tax-free rate might be reduced, or removed altogether.”
Ball also explained the two main strategies currently available for withdrawing this tax-free amount.
“If you are looking to take your tax-free lump sum, you may want to do so now, before rumoured changes come into force, he said.”
“Currently, if you move your entire pension into drawdown, you will get your entire 25 per cent lump sum in one go. It is also possible to drawdown parts of your pension and get 25 per cent of each withdrawal tax-free, rather than all up front.”
Experts warn that reducing this benefit could affect financial behavior among pensioners and younger savers alike. Nick Nesbitt, Head of Private Client at Forvis Mazars, stressed:
“Reducing the tax-free allowance, one of the most well-known and understood benefits of pensions, cuts the attractiveness of pensions further still and runs the risk of people neglecting pension savings. We already have a significant issue in incentivising and encouraging long-term saving in the UK and reducing tax-free cash entitlements would be a step in the wrong direction.”
Inheritance Tax Changes Add Pressure For Pensioners
In addition to the tax-free lump sum reform, another sweeping tax reform is on the horizon. Under current proposals announced in last year’s Autumn Statement, unused pension funds will become liable for inheritance tax starting April 2027. This means that when pensioners pass away, any remaining pension funds will be counted toward their estate and could be taxed at a rate of 40% above certain thresholds.
“Already pension savers are having to contend with the plans for their pension funds to become subject to inheritance tax from April 202B, all said.”
The upcoming change will further complicate estate planning for retirees who have worked for decades to build up financial stability in retirement.
Speaking to Manchester Evening News, Chris Ball highlighted a lesser-known planning option available now to reduce one’s inheritance tax exposure.
“This involves you making regular gifts to, for example, a family member from surplus pension income (after income tax) where the value exits your estate immediately as opposed to the regular seven years. Therefore, it is not subject to inheritance tax, he explained.”
“These gifts can be at a level of your choosing, though you must have enough income to maintain a normal standard of living, he continued.”
“The same exemption provides a useful way to fund trusts for the next generation. This strategy could be deployed to, for instance, help with a grandchild’s school fees or contribute to a family member.”
To help manage inheritance tax exposure, HMRC offers specific gifting allowances that pensioners and savers can use each year. Individuals may give away up to £3,000 annually, divided among any number of recipients. In addition, they can offer an unlimited number of £250 gifts to different individuals, provided those individuals haven’t already benefited from the £3,000 allowance in the same tax year.
