Tax-free pension lump sums could be reduced to as little as £40,000 as Labour looks for ways to plug a £50bn gap in public finances, according to reports. Chancellor Rachel Reeves is considering a range of tax reforms to generate additional revenue without breaching the party’s manifesto pledge to avoid raising taxes on working people.
This potential change to the pension rules could have a significant impact on savers and retirees, who currently benefit from being able to withdraw 25% of their pension pots tax-free, up to a cap of £268,000. The move could generate over £2bn for the Treasury but is likely to spark backlash from pensioners and industry experts alike.
A Push for More Revenue
The UK’s fiscal outlook has been under growing scrutiny, with economists predicting that the Treasury will need to raise as much as £50bn in additional taxes to meet its fiscal targets. This has placed Chancellor Rachel Reeves in a difficult position as she seeks ways to balance the books without breaking Labour’s commitment to not raising taxes on working people.
According to the National Institute of Economic and Social Research (NIESR), the government is set to miss its “stability rule” by up to £41.2bn by 2029-30, while also maintaining a £9.9bn fiscal headroom. As a result, Reeves is exploring a range of tax options to fill this gap, including tightening inheritance tax rules and potentially introducing a “mansion tax” on homes valued over £1.5m.
Despite the urgency, sources suggest that pension reforms, such as the proposed reduction in tax-free lump sum withdrawals, are not yet a top priority for the Chancellor. However, the fact that such measures are reportedly under consideration indicates the scale of the financial challenges ahead for the government.
The Impact on Pension Savers
Currently, pension savers can withdraw up to 25% of their pension pots tax-free, which provides a significant benefit to those approaching retirement. For example, a pension pot worth £268,000 would allow an individual to take £67,000 as a lump sum without incurring any tax liabilities. However, under the proposed reforms, this tax-free amount could be drastically reduced to just £40,000.
Such a change would be a major shift in pension policy and could significantly affect those who have planned their retirement around current pension rules. While the exact details of the proposed changes remain unclear, industry experts have warned that reducing the tax-free lump sum could diminish the attractiveness of pension savings and lead to further complications for retirees.
