The fate of nearly 550,000 benefit claimants currently deemed unfit for work due to serious illnesses such as cancer is in the balance as it emerged that Iain Duncan Smith is planning a radical change to the welfare system.

The work and pensions secretary is pushing to scrap a part of the benefits system that helps sufferers of recent illnesses get back into employment. These individuals are covered by the term "work-related activity group" (WRAG) and are regarded as being capable of work in the future. They are paid benefits if they carry out training or practice interviews.

However, the Observer understands that Duncan Smith wants to disband the group, currently made up of 546,770 people. Such a move would require an overhaul of the whole benefits system, say experts.

The cabinet minister is said to be concerned that only half of claimants in WRAG are coming off benefit within three years, and that hundreds of millions of pounds are being tied up in administration of the benefit, including the work capability assessments and appeals process.

Anne Begg MP, the Labour chairwoman of the cross-party work and pensions select committee, said her fear was that the vulnerable people in that group would be forced to join the dole queue and be at the mercy of the sanction system, under which claimants lose benefits if they do not attend enough interviews or make efforts to find a job.

She said: "My concern is that, if he gets rid of the WRAG group and says all these people are fit to work, that will turn them into job support allowance claimants. Then we have all these people who they are wasting money on trying to get into work, who are realistically never going to get into work and whose condition will be made worse.

"I have two constituents who are psychiatric nurses who have just been telling me about the damage done to people who are ill and incapable and forced to attend job centres."

Begg said she would raise the issue with the minister for disabled people, Mike Penning, when he is due to come before the committee on 11 December.

Stephen Timms, a former Labour welfare reform minister and now shadow minister for employment, said scrapping the WRAG would require "a radical change" to the system on top of a whole series of reforms being pursued by the government.

A Whitehall source said Duncan Smith was championing the major change ahead of the impending publication of the national disability employment strategy. He added that the change was being opposed by the new employment minister, Esther McVey, although a source close to the minister insisted that "any talk of a rift between the minister and the secretary of state is complete nonsense".

A spokesman for the Department for Work and Pensions said: "We're continually looking to improve the system and all sorts of ideas are considered, some of which are acted upon and some of which are not. Ministers are working together closely and we will do everything we can to support this group of people to move off benefits and into work."

A source close to Duncan Smith said any changes to the WRAG could only be understood within the context of the whole system. The source said the department was taking independent advice on reforms of the support allowance paid to the unemployed.

Duncan Smith is already under fire over the government's new universal credit welfare system, through which benefits will be paid to those in and out of work in one payment. Last September the £2.4bn project was described as being poorly managed and riddled with major IT problems by the government's official auditors. The National Audit Office also said that its cost could escalate by hundreds of millions of pounds.

In response, the government said the criticisms had not taken into account recent changes to the management of the reforms.