How Labour's reported plans to cut tax-free pension withdrawals would hit Scotland's public sector workers

Labour is looking at cutting the tax-free lump sum savers can withdraw from their pensions, reports have claimed.

Experts have warned Scotland’s public sector workers could be disproportionately impacted.

The Telegraph claims government officials have asked one of Britain’s top pension providers to assess the impact of reducing the tax-free lump sum to £100,000, a third of the existing limit.

Savers can take up to 25 per cent out of their pensions tax free once they reach the age of 55 - but that allowance may be set to change. Picture: NationalWorld

Currently savers can take 25 per cent of their pension pot tax-free once they reach the age of 55, up to a maximum of £268,275.

The policy, if true, appears to be based on research by both the Institute for Fiscal Studies (IFS) and the Fabian Society, who have argued the lump sum should go from £268,275 to £100,000. The IFS claims the existing system favours the wealthy, and that a change would impact one in five retirees.

In a report published last month: “While there is a case for encouraging people to save at least a certain amount for their retirement, it is hard to justify continuing to subsidise extra saving for individuals with pension wealth little short of £1,073,100.”

In short, it would mean savers are taxed on the amount withdrawn after £100,000, rather than £268,275.

Daniel Hough, financial planner at wealth manager RBC Brewin Dolphin, explained what the policy would mean in Scotland, where more than a fifth of workers are employed in the public sector.

He said: “The changes to how tax-free lump sum cash from pensions reportedly being considered by the Chancellor could see the limit reduced to £100,000 – a significant reduction on the £268,275 under the current rules. While it wouldn’t necessarily affect Scotland in any different way to other parts of the UK, what could make it more relevant here is the way it may affect people with different types of pension schemes.

“For those on defined benefit pension schemes, who tend to work in the public sector, the lack of flexibility over how they draw on their pension could mean they are put at a disadvantage when it comes time to retire. If they are entitled to more than £100,000 of a tax-free cash lump sum when accessing their pension, they could find themselves paying much more tax to do so. Around 22 per cent workers in Scotland are in the public sector, according to Scottish Government statistics.

“This would be less of an issue for people on defined contribution pension schemes. They have a lot more flexibility with how they take money from their savings pot, providing them with more options for how it is managed and when income accessed.

“However, it is important to remember that this all remains speculation – we won’t know what the Chancellor has planned until Budget day at the end of the month. Changes to pensions also tend to take a long time to introduce, so do not do anything drastic and speak to a professional financial adviser before making any significant financial decisions.”

Lily Megson, policy director at My Pension Expert, said savers should not do anything drastic.

She said: “As we approach the first Labour Budget for over 14 years, speculation around potential changes to pension tax rules has intensified. With talk of a fiscal black hole, Chancellor Rachel Reeves will likely present some drastic changes to balance the books, with rumours that the tax-free lump sum and tax relief are in her sights. Naturally, this has left some pension planners feeling concerned.

“However, it’s important that savers take this as what it currently is – speculation. The resurfacing of old comments from Reeves supporting a flat rate of tax relief – which the government has since distanced themselves from – has fuelled much of these concerns, but any changes to tax relief would be deeply unpopular. Tax relief is a major incentive for retirement saving, and with under-saving already a significant issue, such a move would be bold and potentially very risky.

“Rumours have also caused an increase in savers considering withdrawing their tax-free cash now to ‘get ahead’ of possible changes. But people need to understand that nothing has been confirmed, and any changes announced in the Budget are unlikely to take effect until the next financial year at the earliest, giving them ample time to plan accordingly.

“Ultimately, savers should avoid making rash decisions that could harm their long-term retirement plans. Until we have concrete details from the Budget, the best course of action is to stay calm and make well-informed, considered choices.”

Rachel Reeves will deliver the budget on 30 October.

A Government spokesman said: “We do not comment on speculation around tax changes outside of fiscal events.”