Cap on rise in benefits will cut bill by £3.7bn

The move means that upratings are likely to be below inflation in future years, gradually reducing the real value of benefits and breaking the link that has previously seen them rise in line with prices.

But the Chancellor said he would protect the vulnerable by continuing to increase carer benefits and disability benefits in line with inflation.

However, there were claims that Mr Osborne’s raid on pension tax relief could have a damaging impact on middle-income earners.

The announcement fell short of the freeze in benefits that some pressure groups feared, but was still greeted with dismay by anti-poverty campaigners. It comes on top of £18bn in welfare cuts that had previously been announced.

Mr Osborne said it was “fair” that welfare recipients should receive similar increases in income to public sector workers, whose pay is rising by one per cent as a lengthy freeze comes to an end.

The Chancellor added that from 2014/15, the tax-free allowance for pensions will be reduced from £1.5m to £1.25m over a lifetime. The maximum amount that people can pay into a pension annually that is subject to tax relief will be cut to £40,000, from its current level of £50,000.

Meanwhile, Mr Osborne confirmed that from next year, the basic state pension will increase by 2.5 per cent or around £2.70 a week to £110.15 a week.

Mike Smedley, pensions partner at KPMG, said people tend to build up their pensions towards the end of their working lives. “This change will bring more ordinary people, not just fat cats, into the complicated area of tax charges on their pensions entitlements,” he added.