Osborne said to be ready to axe tax-free pensions cash

Steve Webb, the former Liberal Democrat Pensions Minister, has claimed that George Osborne is set to axe the 25% tax-free lump sum from pensions in the Budget in March. It would join a host of pensions and tax changes that could leave some people considerably worse off.

Lump sum

The tax-free lump sum has long-been one of the biggest attractions of saving for a pension. On reaching the age of 55, you are taxed on everything you take out of your pension - but the first 25% can be accessed without paying a penny of tax. Bringing an end to this particular perk would be devastating for millions of people.

Webb claims, however, that its set to go as part of a radical overhaul of pensions announced in the Budget. Those who have already build up pension pots would be safe - he wrote in the Sunday Times - but it would stop people building up any more entitlement to tax free cash, so those with as little as ten years to retirement will face major cuts in the sums they can take out of their pension tax-free.

Instead of the pension as we know it, we would have an ISA-style savings vehicle, where all contributions would be made out of taxed income. It would mean that none of the income taken at the end could be tax free.

Webb's claims carry some weight because he worked so closely with Osborne in the coalition government. He said in the Times that when Osborne announced that a radical overhaul of pensions was being considered, this ISA-style investment was his first choice. Axing the tax-free cash allowance would mean saving the Treasury £4 billion - which is a major attraction for the Chancellor.

However, the Treasury insists that no decisions have been made at this stage. It's also worth bearing in mind that throughout the consultation period, the vast majority of those in the industry have been arguing for a flat-rate tax relief system instead. This would be a major blow to the tax-efficiency of pensions for those on higher incomes - but would retain the tax-free cash benefit for everyone.

What else is coming?

While we can speculate about tax changes to pensions, there are some things we already know about which are set to hit in the next tax year in April. There is some good news, and some bad news.

First, the personal allowance is rising (the amount you are allowed to earn before paying tax). This is currently £10,600, and is set to rise to £11,000 in the next tax year, and £11,200 the year after that. This will mean that the threshold for paying higher rate tax will rise to £43,000 in the next tax year.

The other bit of good news is that there will be a new personal saving allowance, which means the first £1,000 that basic rate taxpayers make on savings income (£500 if you are a higher-rate taxpayer) is tax free. If you make more than this in interest, you'll have to pay tax on everything over the allowance.

There's mixed news for anyone getting dividends. At the moment basic-rate taxpayers don't pay tax on dividend income, while higher-rate taxpayers pay 25%. From April, the first £5,000 you get will be tax free - and above that will be taxed at 7.5% for basic-rate taxpayers and 32.5% for higher -rate taxpayers. If you have plenty of money invested in shares (especially those producing dividends) this is likely to be bad news - especially if you are a basic-rate taxpayer.

There's more bad news for those with large pensions, because the lifetime allowance will be cut from £1.25 million to £1 million.

And there's bad news for buy-to-let investors, who will pay an extra 3% stamp duty when buying a second property (with the knowledge that a year later they will see tax relief on mortgage interest cut).

But what do you think? Are you dreading the Budget - or are you hopeful that you'll end up paying less tax? Let us know in the comments.