In the run up to Rachel Reeve’s first Budget last October, which saw a package of major tax rises, worries that the Government might seek to reduce the amount of tax-free cash that can be taken from pension pots caused panic. In the event, no such moves were made, leaving some who had acted in haste quickly regretting their decision as once a quarter of a pension has been withdrawn it cannot be reversed.
Within a pension your wealth grows tax-efficiently, and the period since the last Budget has also seen strong returns from markets. Those who took cash out that they didn’t need, may have missed out on gains while exposing their cash to tax on savings interest, share dividends and capital gains. However, as we approach the next Budget on November 26, fears about a potential raid on tax-free cash have resurfaced rather than gone away as further tax rises seem inevitable given forecasts of a widening hole in the public finances. This has been exacerbated by the fact that Torsten Bell, the pensions minister, who has been given a leading role in planning for the Budget, previously advocated cutting back tax-free cash on pensions to as little as £40,000 while running the Resolution Foundation, a think tank.
Another factor fuelling moves to take tax-free cash is the step announced at the last Budget to bring unused pension assets into the scope of inheritance tax from April 2027. This is prompting wealthier individuals who had intended to pass on their pensions to their children or grandchildren tax efficiently on death, to rethink their plans, including withdrawing cash to either make lifetime gifts, to pay the premiums on life assurance to cover expected inheritance tax bills or to up their spending rather than leave their wealth to HM Treasury.
However, taking a hasty, major decision around your pension based on speculation about changes that may not happen is very unwise. Worryingly, the data from the FCA found only 30.6% of pension plans accessed for the first time in 2024/25 were held by savers who took regulated advice.
If you were intending to take your tax-free cash in the near future anyway, because you have a specific use for it in mind, such as paying off a mortgage, then taking the cash a few months earlier than originally intended might be fine. Gifting it to reduce inheritance tax could also make sense, but only if you are absolutely confident that doing so will not jeopardise your own financial security and that you have considered your state of health and other options to lessen the impact of inheritance tax on beneficiaries such as insurance. Until April 2027, pensions remain free from inheritance tax, so if you withdraw a large sum now and unfortunately die before April 2027, then those assets will become part of an estate for inheritance tax purposes, potentially landing your loved ones with an even bigger tax bill.
In truth, none of us have a crystal ball to know for sure what will be announced in the next Budget, and the Government is doing little to quell rumours. Were any changes to be made, these would likely require technical consultations and changes to legislation rather than be enacted with immediate effect. It must be hoped that in the event of change to the maximum amount of tax-free cash, transitional arrangements would be made available for those currently eligible to take a higher amount, or on the cusp of doing so, to avoid derailing people’s carefully made plans. There is some precedent here, as previous reductions in the now abolished pensions’ lifetime allowance were accompanied by the ability to apply for protections against such changes.
While worries about the future of tax-free pensions cash may be heightened, such a move is far from inevitable. Reducing tax-free cash would have a gradual effect on tax receipts over time and would not be a quick source of significant revenues. But such a measure, and indeed any major changes to wider pension tax reliefs, would also potentially have a significant impact on public sector professionals, including doctors and consultants in the NHS pension scheme. Parliamentary research estimates 46% of pension tax reliefs relate to gold-plated defined benefit schemes, which now largely remain in the public sector. To avoid a ferocious backlash, the Government would need to provide a controversial carve out that would be seen as unfair to private sector workers and which would also diminish the benefit to the Treasury.
Until we have some clarity over the Chancellor’s plans, the next couple of months going to be unsettling times for those pondering major financial decisions. However, it is vital not to be driven by panic and to carefully weigh up all the considerations and the potential pitfalls before acting.
Jason Hollands is a managing director at wealth manager Evelyn Partners