Rathbones is warning that fears over pension tax changes are driving premature withdrawals of the 25% tax-free lump sum – a move many now regret, according to a survey of investors in the wake of last year’s budget, as speculation builds ahead of November’s Budget.
There has been a recent surge in lump sum withdrawals following reports that Chancellor Rachel Reeves is due to cut the 25% tax-free allowance. A Rathbones survey found that such a decision topped a list of regrets of actions taken by respondents in the run-up to 2024’s Autumn Budget when similar rumours swirled.
While there are legitimate reasons to access the lump sum, such as paying off a mortgage or supporting loved ones, a knee-jerk reaction driven by uncertainty could mean missing out on substantial investment growth and long-term tax advantages.
For example:
• £100,000 invested at a 5% annual return could grow to £128,000 over five years
• In a savings account earning 2%, it would reach just over £110,000, a difference of £17,220
• Over ten years, the gap widens to £41,000 (£163,000 vs £122,000)
In addition, once withdrawn, any future growth on the lump sum typically occurs outside the tax-efficient pension wrapper, potentially exposing it to income tax, capital gains tax, or inheritance tax. Rathbones is urging retail investors to take advice before making decisions as the clamour around potential changes and possible tax grows louder, with weeks still to go until the Budget on November 26.
Rebecca Williams, Divisional Lead of Financial Planning at Rathbones, says: “The pension tax-free lump sum is one of the best-loved and most well-understood parts of the pensions regime, and it’s understandable that people are nervous about potential changes to the rules. The ability to withdraw a lump sum free of tax from your pension is hugely beneficial for meeting immediate financial obligations, but withdrawing without a clear plan can lead to missed growth opportunities and tax exposure.
“With the confirmation from the regulator this week that drawing tax free cash doesn’t trigger cancellation rights, taking tax free cash is an irreversible decision. It’s vital to think carefully before acting. Taking professional financial advice can help ensure decisions are aligned with long-term goals and made with a full understanding of the risks and benefits.”
It is also important to be aware of the Money Purchase Annual Allowance (MPAA), says Rebecca. Once you take taxable pension withdrawals, your annual tax-relievable contributions drop from £60,000 to £10,000 - a rule that often catches people out when trying to rebuild their savings.
“Those thinking they can simply recycle their tax-free cash back into a pension could be in for a nasty shock,” she says. “If the move appears pre-planned and contributions spike significantly, HMRC may treat it as an unauthorised payment - potentially landing you with a tax bill of up to 55%.”
The run-up to last Autumn’s Budget – held nearly a month earlier at the end of October – saw a number of rumours about a wide range of changes which did not materialise, including scrapping or abolishing the 25% tax free pension lump sum, cutting pension tax relief, extending income tax threshold freezes and scrapping the IHT tax break on AIM shares. Those same options are being predicted again.
In 2024, there was speculation that Capital Gains Tax (CGT) rates could be raised to match income tax rates of 20%, 40% and 45% - in the event the lower and higher rates were increased to 18% and 24%. Rathbones research found that:
• 27% of people regretted withdrawing a lump sum from a pension
• 27% regretted selling investments to avoid higher CGT rates
• 5% regretting selling a business to avoid changes to business relief.
|
