Some form of tax pain is expected in the budget, with pensions — particularly the tax-free lump sum — widely expected to be on the chancellor’s chopping block.

Most savers can take up to 25 per cent of the amount built up in their pension tax-free from age 55 (this is rising to age 57 in 2028), up to a maximum of £268,275. But there are fears that Rachel Reeves could reduce or scrap this.

The Institute for Fiscal Studies, an independent think tank, has recommended cutting the tax-free allowance to £100,000, while the pensions secretary and Treasury minister Torsten Bell has previously advocated a £40,000 limit.

Similar speculation in the run-up to last year’s budget resulted in a spike of people taking their tax-free cash early. The Financial Conduct Authority (FCA), the City regulator, said that the number of people accessing pots worth more than £250,000 in the six months to September 2024 was up more than 50 per cent on the year before.

‘I paid off some of my mortgage before my rate went up’

Alan Barnes from Oxfordshire took his lump sum this year. He turned 55 in April amid the tariff turmoil in the stock market and decided that it was a good time to take some cash and reduce his overall equity exposure.

“It made sense to take the full amount because the financial implications of waiting until after the budget could have been substantial,” said Barnes, who is not fully retired and asked not to use his real name.

• The tax grab on pensions is tantamount to theft

He used the money to pay off some of his mortgage before the end of his fixed term in December, when his interest rate will jump from 1.3 per cent to about 4 per cent. “I’ve got no regrets, whatever the outcome of the budget may be,” he said.

So, is now the right time to take the valuable cash from your retirement pot?

The numbers

Any changes to the tax-free lump sum could cost savers dearly.

At the moment, someone with a £1 million pension pot can take out 25 per cent (£250,000) completely tax-free because it would be less than the allowance of £268,275. If the allowance was cut to £200,000 and they still took their £250,000 cash, they would have £50,000 that was taxable, which, after the £12,570 tax-free personal income allowance was taken into account, would mean that a basic-rate taxpayer would pay £7,486 tax, assuming no other income. If the allowance was cut to £100,000 they would have to pay tax on £150,000.

Whether a cut to the tax-free sum would affect your tax bill depends on the size of your pension and when you plan to retire. If you have a £500,000 pension pot and planned to take your 25 per cent £125,000 lump sum, then you wouldn’t pay any extra tax if the allowance was cut to £200,000 or £150,000.

Should you take your lump sum now and invest it?

If you are considering taking your lump sum, it is worth thinking about what you would do with it.

Taking the cash now may be tempting, but it’s a decision to make carefully. Lisa Picardo from the savings consolidation firm PensionBee said: “It may feel like ‘free money’ that could help your finances now if used wisely — to pay off expensive credit cards or personal loans, to repay a mortgage, substitute income for those working part time — or even to treat the grandchildren.

“But every pound withdrawn now is one less invested for the future, which could affect your financial security later in life.”

When running the numbers, take into account when you plan to stop working and any other sources of income or savings, alongside how you plan to use the tax-free lump sum.

The pensions and employee benefits firm Barnett Waddingham and Howden looked at how much tax you would pay in total if you took your tax-free cash now and invested it for retirement outside your pension pot.

• Seven ways the taxman could come for your pension — and what to do about it

Take a saver who is 55, earning £45,000, and five years from retirement. They have a £1 million pension pot and decide to take the maximum tax-free lump sum allowed today of £250,000. If they invested this money, earning 6 per cent a year that was taxed as income, they would pay £18,000 in tax over the five years before they retire. This assumes they have no other income and make use of the personal income allowance.

If they had waited to take their lump sum and the allowance was cut to £100,000, they could pay £76,000 on their £250,000 — £58,000 more than the above example. The sums assume slightly higher investment growth of 7 per cent inside the pension and that the personal income allowance and tax thresholds go up 2.5 per cent a year.

Tyron Potts, the head of pensions research at Barnett Waddingham and Howden, said that those closer to retirement would generally pay less tax if they took their lump sum now, and the allowance was cut. But he said: “It’s important to remember that there is no confirmation that any such change will happen, and decisions shouldn’t be made based purely on speculation.”

Or should you take it in stages?

If you have a defined contribution pension — a so-called pot of money pension, where what you get in retirement is based on how much you pay in and how well your investments perform — you could put your pot into what is known as drawdown and then take your lump sum in stages as part of a regular income.

Say you wanted an annual income of £30,000 from your £1 million pension pot. You would get 25 per cent of your withdrawal tax-free (£7,500) and you could take £12,570 tax-free under the personal allowance. This would leave a withdrawal of £9,930 that you would pay 20 per cent income tax on, giving you an annual tax bill of £1,986.

• I’m a pensions expert and I’m taking my tax-free cash now

If you had already taken all your tax-free lump sum, then £17,430 of your £30,000 income would be taxable, once you had taken into account the personal allowance, giving you a tax bill of £3,486.

The risk in rushing

HM Revenue & Customs said that there were “no legislative provisions for tax-free lump sums to be returned to a pension and for the tax consequences to be undone”, with decisions not covered by statutory 30-day cancellation rights.

This means that if you panic and take out your lump sump before the budget, you may not be able to put it back if you change your mind.

Laura Pomfret, who started the personal finance app Financielle, said decisions around the tax-free lump sum can be overwhelming and advised anyone considering it to speak to an expert.

She said: “While it can be nice to access your hard-saved cash, the trade-off is less money to sustain a suitable pension income later in life and a loss of the potential growth that money could have earned if it stayed in the pension.”