The tax-free pension lump sum has its problems, but is limiting the allowance actually a good idea, asks Daniel Herring

In order to plug the holes in her upcoming Budget, Rachel Reeves is reportedly planning a fresh tax raid, this time on the tax-free pension lump sum.

At the moment, anyone over 55 can withdraw a quarter of their pension pot tax-free, up to a maximum £268,000. The Chancellor apparently wants to limit this to just £40,000.

How does the tax-free lump sum work?

The tax-free lump sum is a funny quirk of our pensions system. In general, you get tax relief on the money paid into a pension pot, but pay tax as you withdraw it. In other words, your income is still taxed, just at a later point in your life. The tax-free lump sum, however, means that a portion of your pension escapes the taxman – acting not just as a pleasant way to start your retirement, but an incentive to save in the first place.

Purist economists would say that, strictly speaking, the lump sum does not comply with good principles of taxation. It benefits those with bigger pension pots most,........

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