Rachel Reeves has been warned that making changes in the Budget to the amount of cash people can withdraw tax-free from their pensions is a “high risk strategy” which would create a “political storm”.
The Chancellor is looking at a range of tax rises to try and fill and £20-£40bn hole in her budget without breaking her manifesto pledge not to raise income tax, VAT or employee national insurance contribution.
A significant source of funding would be to reduce the amount pension savers can take from their pot tax-free each year.
A new report from the influential Institute for Fiscal Studies think-tank has recommended that the Chancellor should look at reforming this tax-free element which retirees can take from their pension income.
In its report, the IFS said that the tax-free 25 per cent offered on all pension withdrawals up to a cap of £268,275 is “ripe for reform”.
The think-tank said the current system provides the largest benefit to those with the highest retirement incomes and “subsidises saving for those who have already accumulated big pension pots and are at no risk of under-saving”.
It has previously recommended cutting the 25 per cent tax-free cap to £100,000, estimating this would impact one-in-five pensions and raise around £2bn a year.
With Reeves expected to have to raise tens of billions in her Budget to fill a gap in the public finances, some experts think a change to the way pensions are taxed is on the cards.
Rob Wood, chief UK economist of Pantheon Macroeconomics, told The i Paper: “We expect the Chancellor to lower the maximum tax-free lump sum to £100,000.
“Taxes always create distortions so the Chancellor should be mindful of the impact on the incentives to save,” Wood said.
But he added: “Equally allowing a large sum to be withdrawn from a pension free of further tax is worthy of reform.”
The pensions minister Torsten Bell – who has been given an elevated role in helping to shape the Budget – previously called for tax-free cash to be capped at £40,000 when he was running the Resolution Foundation think-tank.
When asked the Treasury did not dampen speculation. In a statement it said: “We do not comment on speculation around tax changes but remain committed to encouraging pension saving.
“Pension savers already benefit from around £78 billion a year in tax reliefs as the majority pay no tax on their contributions.”
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However, Steve Webb, a partner at pensions consultants LCP and a former pensions minister, said that such a move would backfire on Reeves.
He told The i Paper: “Touching tax-free cash would be a high risk strategy for the Chancellor.
“A particular challenge is that those close to pension age would need to be protected from a last minute change to the tax rules.
“But as soon as you create complex protections, you end up raising little money from the policy for years to come.
“Creating a political storm by attacking the ‘sacred cow’ of tax free cash whilst generating very little revenue before the election feels like a lose-lose for the Chancellor”.
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