Derek Scott (former chair of the Railway Pension – author of this blog

As a DB trustee, I sometimes wondered where the 25% tax free lump sum came from.

Apparently it started back in an Edwardian age, when civil servants were granted a lump sum at retirement in return for a lower pension thereafter, by the Superannuation Act 1909.

Inland Revenue (whose own civil servants could also take the lump sum option) was asked whether such lump sums would be taxable, and said that they would not be.

Inland Revenue gave no reason for this decision, although presumably one reason was that the lump sum was a capital payment, not income, at a time when capital was not taxed.

This exemption was later supported by legislation such as the Income and Corporation Taxes Act 1970.

You may argue there is no logic to this basis today, when there are various capital taxes, but it’s a fact lump sums (where permitted under the rules of many, but not all, schemes) have remained tax-free ever since.

The permitted size of the tax-free lump sum has, however, been changed by legislation.

Before the introduction of so-called pension tax simplification in April 2006, the amount of any tax-free lump sum that could be made depended on which tax regime applied.

For instance, shortly after I first became a trustee in 1987, the main set of new tax rules for DB occupational schemes (known as the 1989 regime) provided that the

“tax free lump sum at retirement is limited to 2.25 times initial pension or 3/80ths of final remuneration for each year of service up to 40 years.”

For personal pensions, tax rules dating from 1988 allowed tax-free lump sums of up to 25 per cent of pension savings.

Previous Labour Governments seemed to believe retaining an option of a tax-free lump somewhere in the mix encouraged pension saving.

The argument was pensions should receive favourable tax treatment to encourage people to save for their retirement, to lock away money, perhaps for decades, until they needed to draw benefits from their pension savings in their later years.

The tax-free lump sum was said to provide some of that encouragement.

As a trustee concerned for the welfare of members, I believed the option could provide a substantial capital sum, perhaps allowing people to put their financial affairs into better order when they retired.

Or perhaps it might offer once in a lifetime opportunities such as visiting family overseas, taking round-the-world cruises (rather than ordering Lamborghinis) or paying for home improvements to make retirement more comfortable.