Pension Tax-Free Cash Under Attack, Savers Could Lose Thousands


In a stealth raid, Jeremy Hunt has quietly set a cap on the amount of tax-free cash that pensioners can withdraw from their pensions. This new cap will have damaging consequences for savers due to a phenomenon known as fiscal drag. This occurs when tax thresholds are frozen while asset values rise, resulting in a stealth tax. Financial experts warn that the new cap is unlikely to increase and could significantly reduce the value of the 25 percent tax-free cash for those with larger pension pots. Failure to take action could result in savers losing thousands of pounds in tax to HM Revenue & Customs.

The Background

In the March budget, Jeremy Hunt abolished the pensions lifetime allowance, which previously capped the total amount savers could hold in their pension pots at £1,073,100. This abolition was done to encourage NHS doctors to work later in life, as many had retired early to avoid penalties. However, critics failed to notice that the Chancellor had also set a new maximum cap of £268,275 on the tax-free cash element for everyone. This move drew criticism from Labour who claimed that Hunt was giving a tax break to the super rich.

The Consequences

According to experts at Quilter, a leading pension provider and financial adviser, the cap on tax-free cash could have major knock-on consequences for pension planning. While the initial impact may be small, more and more savers will see their tax-free cash shrink as their pension grows. The cap of £268,275 represents 25 percent of the previous lifetime allowance threshold of £1,073,100. As the value of larger pension pots continues to rise, savers will no longer be subject to the lifetime allowance surcharge. However, they will also no longer be able to take 25 percent of their pension tax-free.

The Loss of Tax-Free Cash over Time

The frozen cap on tax-free cash means that as the value of pension pots increases, the tax-free cash will shrink in real value. For example, someone with a pension worth £1.07 million today could lose nearly £37,000 of available tax-free cash after five years. After a decade, the tax-free cash would be worth just 14 percent of their pot, resulting in almost £70,000 in extra tax. This could impact approximately 1.6 million pension savers in the next three years, with the number increasing over time. The most affected are likely to be those in defined benefit “final salary” company schemes.

Possible Solutions

One option for those affected is to withdraw the tax-free cash while still within the £268,275 threshold. However, this is not ideal as it means withdrawing money from a pension before it is actually needed. Pensions offer attractive inheritance tax benefits as they are not subject to IHT. Once the money is withdrawn from the pension, it becomes part of the saver’s estate and may become liable to inheritance tax upon death. Additionally, any future growth on the money becomes taxable once the tax-free cash has been withdrawn.

Alternative Options

Experts suggest considering the use of other investment vehicles to shield returns and manage future tax liabilities. One such option is utilizing the annual tax-free £20,000 ISA allowance. This option can help protect ongoing returns from being subject to tax. Additionally, offshore insurance bonds may be an attractive option following the pension reforms. These bonds can help control tax liabilities, simplify tax reporting, and be placed within a trust for inheritance tax planning purposes. However, offshore bonds can be complex, and it is advised to consult an independent financial adviser to determine the best strategy.

Future Concerns

There is a possibility that pension tax could become an even bigger issue if Labour wins the next election, as the party has vowed to restore the lifetime allowance. Furthermore, the Treasury may decide to eliminate tax-free pension cash altogether, although this would likely be met with strong opposition from the public. The ability to withdraw tax-free cash from pensions is a great benefit for many individuals, often used to pay off mortgages, debts, or fund significant expenses such as a new car, home improvements, or dream holidays.


Even those with more modest pension pots need to carefully plan their tax-free withdrawals. Taking smaller, regular withdrawals over time can help save tax compared to taking the whole amount in one go. It is important to consider the long-term consequences and seek expert financial advice to ensure that pension savings are maximized and tax liabilities are minimized.