Chancellor Rachel Reeves is intensifying anxiety among pension savers in the lead-up to the Budget by not dismissing the possibility of taxing the 25 percent tax-free lump sums.

This worry mirrors the apprehensions faced by individuals nearing retirement before last year’s 2024 Budget announcement.

Several who withdrew their tax-free lump sum prior to last year’s Budget now express regret, feeling compelled to make a choice that could potentially diminish their financial security in retirement.

The current rule allows pensioners to withdraw up to 25 percent of their pension tax-free, with a maximum limit of £268,275. Typically, this can be accessed at age 55, but this age is set to increase to 57 by 2028.

The Government has remained silent on whether it intends to lower this limit or introduce a cap, possibly around £100,000, as proposed by the Institute for Fiscal Studies, a prominent think tank.

Money Mail has reached out to some disheartened savers who opted to withdraw funds before last year’s Budget, now grappling with the repercussions of their decisions.

Suffering some sleepless nights

Single mother Joanne Smith has suffered sleepless nights ever since she felt panicked into taking the 25 per cent lump sum from her personal pension last year.

The marketing consultant from Southampton said she felt physically sick when she made the decision last year – just weeks before the Chancellor eventually decided she would not plunder pension pots in the autumn Budget after all.

The 58-year-old single mother of two says: ‘I was in a total panic and am furious at being pushed over the edge by a Government that refuses to say what it actually plans to do – and cannot be trusted to support working people. 

What really makes me angry is that once the lump sum has been taken out it cannot be put back in again. It means I am now losing out on tax-free earnings. This is made worse because my pension pot is now smaller.’

Joanne, a consultant in the construction industry, chose to take a £250,000 lump sum from her £1 million pot because she planned to use the tax-free cash for herself and also to support her two 11-year-old children who started secondary school in September.

She says: ‘It was horrible. One of my children is autistic while the other was being badly bullied at primary school. I have saved since they were born to pay for a private secondary school education.

‘But last year I realised to guarantee the tax-free cash would be available when I needed it, I would have to dip into my private pension much earlier than I’d planned. 

There was no certainty the Government would not plunder my hard-earned savings in the Budget. I could not afford the risk.’

Joanne has now put this money into savings bonds on the advice of a financial adviser. But the marketing consultant is not happy because she had hoped to keep the money growing tax-free in stocks and shares within her pension.

She calculates it has cost her thousands of pounds in lost income she hoped not to touch for years. That is because now the money is no longer in her pension, interest or investment returns that she earns on it are taxable.

She adds: ‘My father was a butcher and used to get up every day at 4.30am to start his job. Thanks to his scrimping and saving, I was given a private education for which I am grateful. 

With the Government adding VAT to the bill, it means finding another £100,000 to fund my children’s education. I have no problems with working – and do not expect to stop until the age of 70. But you must be fair.’

Forced to keep on working

Bob Gorman felt forced into taking his pension lump sum early last year – and now feels conflicted because his partner is facing the same dilemma today.

The semi-retired 60-year-old former British Telecom engineer moved to the Dorset coastal town of Poole last year with his wife, 59, so they could both enjoy early retirement. 

Bob suffered a health scare 20 years ago when successfully treated for leukaemia, and this motivated him to try to stop working in his 60s.

He says: ‘I regretfully took out all my tax-free lump sum from my drawdown pension scheme because of concerns before last year’s Budget that the allowance was due to be cut.

‘This has affected my pension growth because I have now put it into a savings account where money gets taxed rather than continues to grow tax-free.’

Bob was concerned that the cap was going to be cut to £100,000 so took a total of £118,000 as a 25 per cent allowance from a combined BT company pension and Standard Life private pension in September last year, a month before the autumn Budget.

He says: ‘I asked my pension providers for reassurance that my pension lump sum would be safe, but no one could give it. 

‘It used to be that the Budget was a time for putting a few pence on the price of a packet of cigarettes and a pint of beer – but knowing this Government wants to punish those who are coming up to retirement meant I feared they might dash all our dreams.

‘It is an absolute disgrace that this Government is allowed to move the goalposts to fill holes in its own finances.

‘I have never claimed a penny in benefits and worked hard since leaving school at 16. There was no way I was going to give the Chancellor a chance to dip into my pension pot.’

Bob and his wife are expecting to live on a combined income of little more than £40,000 a year after Bob’s decision to take the lump sum early.

As a result, Bob has decided to take a part-time job as a delivery driver to subsidise their income. He retired from BT after 36 years of service in May last year.

He adds: ‘Now, a year later, we are being gaslit by the Chancellor all over again. My spouse is in the exact same position I was this time 12 months ago. 

She works as a doctor’s receptionist and also wanted to start taking things easy to enjoy our retirement by the sea. I don’t understand how you can work hard all your life and be punished for being prudent – wanting to save for old age.’

Missed chance on annuity rates

David Janes believes the uncertainty caused by a potential attack on his pension savings rushed him into making decisions that could harm his retirement plans. 

Widower David, who now lives with a partner in a two-bedroom bungalow in Brighton, has a £24,000 public-sector pension, plus £12,000 widower pension, state pension and other retirement plans that take annual income to just above the £50,271 threshold for higher rate tax.

His 61-year-old social worker partner is not yet planning to retire due to concerns that it will badly affect their income.

David, a 66-year-old retired local authority treasury manager, says: ‘I have a separate self-invested personal pension [Sipp] and took out a £35,000 lump sum from this pot last year for fear of restrictions that might be imposed in the Budget.

‘I have put this cash into stocks and shares Isas over two years – taking advantage of the £20,000 annual limit. 

Suggestions the limit for cash Isas be halved to £10,000 in the Budget concern me as, once again, it will make pension planning more restrictive for many people. Cash is a safe asset that is more important in retirement.’

He adds: ‘As a qualified accountant, I did not feel panicked into making the decision last year – but was still forced to make retirement decisions early for fear of possible changes. This should not be allowed to happen.’

David says he has some slight regrets about not buying an annuity at the time, when rates were very competitive.

‘There was just too much uncertainty about the Budget,’ he says. ‘Instead, I took a lump sum while I still could and put the money into Isas.’ 

Annuity rates are linked to the Bank of England base rate that currently stands at 4  per cent. 

Provider Legal & General says a pension pot of £100,000 might buy an annuity of £4,815 for a single 65-year-old man right now.

The rates have steadily improved in the past couple of years – from a typical 5.8 pc at the start of 2024 to almost 7 per cent now. Such a difference can be worth £1,000 a year.

But some economists predict rates could begin to fall in the future if the 3.8 pc rate of inflation starts to go down – and the Bank of England is able to drop its base rate.

The key questions to ask before you act

Do not take tax-free cash out of your pension unless you have a clear plan for your hard-earned retirement savings.

That is the message being hammered home by pension experts, who are worried that people will harm their retirement finances if they withdraw cash based purely on speculation about a Budget raid that might never happen.

Those over the age of 55 can take 25 pc of their pension pot tax-free up to a £268,275 cap. There are concerns that this could be slashed in the Budget and the Chancellor has refused to rule out a move. Fears that the Government will target tax-free cash on November 26 have prompted a rush of withdrawals, say pension firms.

Former pensions minister Sir Steve Webb doubts that Chancellor Rachel Reeves will dare to wreck people’s retirement plans by lowering the cap or abolishing tax-free cash.

‘It would create uproar among those who were close to retirement and had planned their finances around having access to a tax-free lump sum,’ he says. ‘Most people would feel that a change like this was like “moving the goalposts” and was fundamentally unfair.’

If Reeves does defy warnings to leave pensions alone, Sir Steve believes that transitional protections will be put in place. But there is no guarantee of that, so many who are eligible to take tax-free cash are wondering whether to take pre-emptive action.

We asked industry specialists AJ Bell, Aviva, Royal London, People’s Partnership and Lane Clark & Peacock to explain how the process works.

Do you need to take tax-free cash?

Many savers use it to clear remaining mortgages and other debts, splash out on home renovations and new cars, or book a dream holiday. With pensions due to be pulled into the inheritance tax net from April 2027, some are also taking cash to give away early.

For some people taking the cash could pay off, especially if they planned to do so anyway in the next year or so and want to spend the money for a specific purpose.

Tax-free withdrawals are irreversible and you may miss out on future investment growth by shifting funds out of your pension. But deciding to hold off means banking on the rules not changing, which is also a risk.

What are sources of tax-free cash?

Those with defined benefit work pension schemes have a commitment from their former employer to pay them a retirement income. They can take a 25 pc tax-free lump sum but it will lower their future annual income.

Their pension scheme will confirm the exact figures. As soon as you take the tax-free lump sum, your payments will start too.

Turning a defined contribution work or personal pension into retirement income usually involves either buying an annuity – a financial product that provides an income for life – or remaining invested and making withdrawals to fund retirement.

You have three options open to you to get tax-free cash.

You can take the 25 pc and use the remaining fund to buy an annuity; take 25 pc tax-free cash and leave the rest invested in a process called drawdown; or leave the whole pension invested but each time you make a withdrawal 25 pc is tax-free and the other 75 pc is taxed.

You could also withdraw your entire pension, with the first 25 pc tax-free and the rest taxed. But this could leave you with a large tax bill.

How do you get your cash?

Go online or phone up your defined contribution work pension administrator, or your private self-invested personal pension (Sipp) provider.

You will have to go through various verification checks, including on your age. You need to be 55 to access your tax-free cash (this will go up to 57 from April 2028).

You might be asked your reasons for making a tax-free cash withdrawal, to check you aren’t being scammed and are making an informed choice.

Before you finalise your decision, you should be told about the free independent help available from the Government-backed Pension Wise at moneyhelper.org.uk.

Your pension scheme will also probably flag up the benefits of paying for financial advice. An adviser can help you avoid tax traps and other costly errors, and plan for inheritance.

Make sure you understand any tax questions you are asked and answer them precisely. HMRC could impose a tax charge if you give incorrect information.

If you don’t have cash available in your pension pot, taking a tax-free lump sum involves selling some pension investments.

You can let your scheme sell them in equal proportions from any funds you hold, or make an active decision about investments to cash in.

If you have a Sipp, you should sell assets yourself to ensure you have enough cash available in your account.

Finally, you will reach the settlement stage, which is when your scheme processes and releases your cash to you.