Why is HMRC blocking me from taking a 33% tax-free lump sum from a pension? STEVE WEBB answers

I turned 55 in February and wanted to withdraw the tax-free amount I could from one of my pensions.

My financial advisor told me in 2023 that for some reason I could take an improved 33 percent instead of the usual 25 percent. I think this had to do with when I first took out the policy, which was even better news.

When I tried to apply for the release of the money in February this year, I was told that the Tax Authorities had suspended the case because there was uncertainty as to whether the 33 percent would still be allowed due to a new rule.

My pot in this particular pension is worth £72,000. So that’s about £6,000 less if I take 25% instead of 33%, which is obviously not my preference.

I don’t know if I should wait until the situation with the Tax Authorities is cleared up or if I should just continue taking the 25 percent. I would like to get started and have some improvements done to my house, but I don’t want to miss out on the old increased payment if that is possible once the Tax Authorities have made a decision.

Can you provide me with more clarity on this?

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Steve Webb responds: Unfortunately, you have been caught up in the chaos created by the previous government’s decision to hastily abolish the Lifetime Allowance, a tax break for pensions.

As you may know, the then Chancellor of the Exchequer, Jeremy Hunt, shocked everyone in the March 2023 Budget by announcing that the £1,073,100 lifetime limit on the amount of pension savings you could build up while taking advantage of tax breaks would be abolished.

Because the March budget was adopted just weeks before the start of the 2023/2024 tax year, there was insufficient time to amend all the necessary legislation to fully implement the change before 6 April 2023.

So for 2023/24, the LTA was maintained, but the penalty tax for exceedances was set to zero. In 2024/25, the LTA was abolished altogether.

Unfortunately, abolishing such a limit is not as simple as it seems.

There were literally hundreds of references to the LTA spread across various pieces of legislation and HMRC had to consult on exactly how the LTA could be removed without unintended consequences.

They also had to figure out how to design and implement an entirely new lifetime limit on tax-free lump sum payments.

Many experts within government and the pension sector warned that this was a hasty approach and that the work could not be completed before April 2024. However, due to the political planning of the upcoming elections, these warnings were ignored.

As a result, HMRC has admitted that they still do not have all the necessary legislation in place to make the new system work properly.

One group of people affected by this are people like you who have ‘protection’ that makes their pension position particularly favourable.

In your case, it appears that you started saving for your pension before 2006. At that time, it was still possible to withdraw more than 25 percent of your pension pot as a tax-free amount.

When the 25 percent limit was introduced in 2006, those who already enjoyed these more favorable terms were allowed to keep them, under certain conditions.

Currently, HMRC has stated that it is not its intention to undermine the protections enjoyed by someone in your situation, but warns that the legislation in its current form does not fully achieve this.

It’s also unclear whether the way your lump sum payment is counted towards the new lifetime tax-free money limit has been implemented correctly.

This puts pension schemes and pension providers in a difficult position.

They don’t want to pay you on the generous terms you expected, only to find that detailed legislation says they shouldn’t have.

This could put both you and the other person at risk of a fine for making an ‘unauthorised’ payment.

If you can manage without money for the time being, it might be wise to wait until the legal uncertainty is resolved.

HMRC have said they are working on the matter and will resolve matters ‘as soon as parliamentary timescales permit’, but we don’t yet have a firm date for when this will all be completed.