‘This is the beginning of the end of tax-free pension cash’

The lifetime allowance has been abolished, could tax-free cash be next, asks Steve Webb

Buried in the small print of last week’s Budget was a decision that I think could signal the slow death of taxfree lump sums for pension savers.

When the Chancellor first announced the abolition of the lifetime allowance – the limit on how much pension you can build up with the benefit of tax relief – it seemed like it opened the way to unlimited tax-free cash. After all, if you can take 25pc of your pot tax free, and the pot can now be as big as you can afford, there would be no upper limit on the tax-free lump sum.

However, what the Chancellor did not say in his speech was that the amount of tax-free cash would still be limited. The new limit will be 25pc of this year’s lifetime allowance. This means with a current lifetime limit of £1,073,100, the cap on tax-free cash will be a quarter of this or £268,275. This cap will remain in place even when the lifetime allowance itself has gone.

While this is a large figure, and much more than most people could hope to build up, this is not the end of the story.

Once figures are set in the tax or benefit system, they have a habit of getting stuck if there is no obligation to increase them each year. You only have to think of things like the £10 Christmas Bonus or the 25-pence age addition on ‘Once figures are set in the tax system, they have a habit of getting stuck with no obligation to raise them’ the state pension for the over-80s, both of which have remained unaltered since the 1970s, to see what can happen when rates are set and then forgotten.

The first thing that will happen is that the £268,275 figure will remain at exactly that level year after year. This means that inflation will steadily erode the real value of that tax break. But the next thing that might happen is that a future chancellor could decide this is a lot of money to allow people to draw tax free and that a lower figure – perhaps £200,000 – would be fairer all round. There might be some transitional rules to protect those who were already over this figure, but for the rest of us the limit would be at the lower level.

And once the precedent had been set that the figure could go down, there would be nothing to stop another cut in a future Budget – exactly the sort of thing we have seen with repeated cuts to lifetime and annual allowances over the last 10 years.

In short, while we are very unlikely to see the abolition of tax-free cash overnight, Wednesday’s announcement is likely to end in a death by a thousand cuts. A mixture of inflation eroding the value of the limit and deliberate Treasury decisions to cut the figure in future mean that the days of generous tax-free cash alongside your pension are likely to be numbered.