Steve Webb: Pension tax-free lump sums set for ‘extinction’


Chancellor George Osborne is to announce a dramatic overhaul of pensions taxation, according to former pensions minister Steve Webb, including the “extinction” of tax-free cash.

Speaking to the Sunday Times, Webb says Osborne is likely to flip the retirement taxation regime on its head so pensions are taxed in a similar way to Isas in his March Budget, but the former minister also notes this will include abolishing the right to a 25 per cent tax-free lump sum.

Webb, now director of policy at Royal London, says the Chancellor is likely to avoid alternatives, including introducing a flat-rate of relief, seeking instead to gain from the earlier yield of taxing pension contributions up front.

Webb says: “I do not believe that the flat-rate was ever the Treasury’s first preference.”

However, he adds this will likely lead to the end of tax-free cash.

He says: “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.

“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. Since all of the money that goes in to a pensions Isa has already been taxed, there is no equivalent of the tax-free lump sum.

“Given that the tax-free lump sum costs the chancellor around £4bn 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.”