Why is HMRC preventing me from receiving a tax-free lump sum of 33% of my pension? STEVE WEBB answers

I turned 55 in February and was planning to withdraw the tax-free lump sum allowed from one of the pensions I have.

My financial adviser told me in 2023 that for some reason I would qualify for an enhanced interest rate of 33 per cent instead of the usual 25 per cent (I think it was due to the timing of when I first took out the policy), which was even better news.

When I came to apply for the money to be released in February this year, I was told that HMRC was delaying things because there was some sort of uncertainty about whether the 33 per cent was still allowed due to a new rule.

My fund in this particular pension is worth £72,000, so there is a difference of around £6,000 if I take 25 per cent rather than 33 per cent, which is obviously not what I would prefer.

I don’t know if I should wait until the situation with HMRC is clear or just go ahead and collect the 25 per cent as I’m keen to get on with it and do some home improvements but I don’t want to miss out on the old enhanced payment if possible when HMRC have decided what’s what.

Could you shed some light on this for me, please?

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Steve Webb answers: Unfortunately, you have been caught in the mess that has arisen from the previous government’s decision to rush through the abolition of the lifetime pension tax allowance.

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

Because the March Budget was made just weeks before the start of the 2023/24 financial year, there was not enough time to change all the legislation needed to fully implement the change before 6 April 2023.

Thus, for the year 2023/24, the LTA was maintained, but the tax penalty for those exceeding it was set at zero. In 2024/25, the LTA was completely abolished.

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

There were literally hundreds of references to the LTA spread across different pieces of legislation and HMRC had to consult on exactly how to remove the LTA without having unintended consequences.

They also needed to determine how to design and implement a new lifetime limit on tax-free lump sums.

Many experts within the government and in the pensions industry warned that this was being done in haste and that the work could not be completed by April 2024, but the political calendar of an upcoming election meant that these warnings were ignored.

What has happened as a result is that HMRC has admitted that it does not yet have all the legislation necessary for the new system to work properly.

One group of people affected are those who, like you, have “protections” that make their pension position particularly advantageous.

In your case, it sounds like you started saving for your pension before 2006, when it was possible to withdraw more than 25 per cent of your pension pot in a single tax-free lump sum.

When the 25 percent limit was introduced in 2006, those already on these more favourable terms were allowed to keep them subject to certain rules.

HMRC has said today that it has no intention of undermining the protection enjoyed by someone in his situation, but has warned that the legislation as it currently stands fails to achieve this aim.

It is also not clear that the way your lump sum would be “scored” against the new lifetime limit on tax-free cash has been properly implemented.

As a result, pension systems and pension providers are in a difficult position.

They don’t want to pay him on the generous terms he expected only to discover that the fine details of the finalised legislation mean they shouldn’t have.

This could put you and them at risk of receiving a penalty for making an “unauthorized” payment.

If you can get by without the money for now, it may be worth waiting until the legislative uncertainty is resolved.

HMRC has said it is working on the case and will sort things out “as soon as the parliamentary timetable allows” but we don’t yet have a firm date for when everything will be ready.