Chancellor George Osborne could scrap the tax-free lump sum on retirement incomes in a bid to save the Treasury up to £4bn (€5.1bn; $5.7bn) annually, a former pensions minister has claimed. Liberal Democrat Steve Webb, who led pensions reform during the coalition years, said the "tax bombshell" could affect hundreds of thousands of Britons each year.

Writing in the Sunday Times, Webb said the chancellor was mulling abolishing tax breaks on pension contributions entirely in favour of an Isa-style system in which tax is paid up front. "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," Webb wrote.

In the current system, people do not pay any tax up front on pension contributions and only pay tax when they take money out during retirement. A quarter of the pension pot can be accessed tax-free at the age of 55. In contrast, the tax on pension savings will have to be paid up front in an Isa-style system, meaning every penny withdrawn in retirement is already taxed.


"To the chancellor, the big attraction of the 'pensions Isa' is that he suddenly gets a tax windfall," Webb observed. "For all of today's workers who would have been deferring tax on their earnings by putting their money into a pension, the tax has to be paid right now, as soon as it is earned.

Steve Webb
Steve Webb was pensions minister in David Cameron\'s coalition government between 2010 and 2015 Reuters

"It is true that they will pay no tax when they retire, but that is the problem of a future chancellor. In a sense, Osborne would be double-dipping: benefiting both from the tax due on the pensions of today's retired population as well as the tax due on the earnings of today's workers, even though the latter are locking their money away in a pension."

The change could affect up to 20 million people of working age currently saving for later life, although pension pots already built up will be safe from the chopping block.

"While getting rid of the tax break on lump sums that have already been built up would be politically toxic, the Isa approach would stop people building up any more tax-free lump sums on future pension savings," Webb wrote. "Even for someone ten years away from pension age, this could have a big impact on their retirement planning."