Savers facing £4bn pension ‘bombshell’

GEORGE OSBORNE is planning to abolish the tax-free lump sum on retirement incomes in an attempt to raise £4 billion in lost revenue, according to a former pensions minister.

Steve Webb, who worked with the Chancellor on pension strategy in the Coalition, said the Treasury was plotting a “tax bombshell” that will hit hundreds of thousands of people.

Mr Webb said the perk, which allows people to access 25 per cent of their pension pots tax-free in a single lump sum when they reach 55, was “heading for extinction” in the Budget next month.

Mr Osborne would like to scrap all tax relief on pension contributions and replace it with an Isa-style system, the former minister wrote in The Sunday Times.

In recent months, speculation about pension reforms has focused on proposals to equalise the rates of pension tax relief between all taxpayers. This would hit higher-rate taxpayers.

But Mr Webb, who now works for the pensions firm Royal London, said contacts with Treasury officials had convinced him that Mr Osborne wants to take the more radical course. “I do not believe that the flat rate was ever the Treasury’s first preference,” he said.

The Isa approach would mean “an extra tax bombshell” that “seems to have gone almost completely unnoticed”, Webb writes, because it would scrap the tax-free lump sum. Under the current system, you can get tax relief on your pension contributions, enjoy tax-free growth in your pension fund and then take a quarter out tax-free — a hugely tax-advantaged way of saving,” he wrote.

“In effect, a quarter of the money in your pension never gets taxed at all under the current rules.

“But with a pensions Isa, this tax break quietly disappears.

“Given that the tax-free lump sum costs the chancellor around £4 billion per year in lost revenue, it is easy to see why he might like to get rid of it. It is remarkable to think that one of the most popular and best understood parts of the tax system – the tax-free lump sum – could be on the brink of extinction without anyone noticing.”

Earlier this month, analysis by Hymans Robertson, a leading pension consultancy, said that scrapping higher-rate tax relief on pension contributions would “penalise” middle-class savers even further and discourage them from saving for retirement.

A Treasury source said a decision on the lump sum had not been finalised.

Last night, a Treasury spokesman said: “The Government launched a wide-ranging consultation into pensions tax relief last summer. We have not decided on whether or how to reform the system, and are considering all options, including retaining the current system.

“This consultation is now closed, and we will respond at the Budget.”