Lots of people are worried about the potential tax rises that could be announced in the upcoming Budget on 30th October 2024.
The government is coming for your wealth and therefore we are all searching for hints of what might be put out.
One of the most insightful reports on this, especially when it comes to what might happen to pensions, has recently been released by LCP.
LCP are a consultancy firm, providing research in various sectors including pensions.
The report is worth taking note of because it was part authored by former Pensions Minister Sir Steve Webb.
Sir Steve Webb was a former Liberal Democrat MP and Minister for Pensions under the coalition government.
His body of work during that time includes the State Pension ‘Triple Lock’, the introduction of workplace auto-enrolment pensions and ‘Pension Freedoms’.
Since leaving parliament he has worked for a major pension provider in Royal London, regularly writes on pensions for the Daily Mail and is now a partner at LCP.
He has in fact worked in the pension world since 2001 when he was the Liberal Democrat spokesperson on pension.
The man knows his stuff, has been at the heart of government in terms of pensions and can provide great insights into their long-term thinking.
This is why we should take note when he suggests what the government could be planning to do.
The cost of pension tax relief
In the introduction of LCP’s Pensions, Tax and the Budget report there is a really interesting table that outlines how much the current pension tax relief system costs the government.
The combined cost of Income Tax relief on employee, employer, self-employed pension contributions and investment returns of pension funds comes to £46.8bn.
On top of this employers currently get National Insurance relief on employer pension contributions and this costs an additional £23.8bn. We will come back to this shortly.
The report has deducted the amount of Income Tax and other tax charges that come from pensions in payment bringing the total net cost of pension tax relief to £48.7bn.
Looking at the size of these numbers you can see why the government might be so keen to tweak the pension system to find extra tax revenue.
Having ruled out increases to Income Tax, National Insurance and VAT which make around two thirds of all tax revenues, the report believes there is not much else the government can do apart from attack pensions.
One of the big rumours that has been swirling around is the idea of a flat rate of tax relief. So rather than higher rate taxpayers getting full tax relief on pension contributions they could potentially lose out by only getting basic rate tax relief for example.
LCP do not believe a flat rate of tax relief is likely as they believe it would be complex to implement, create millions of ‘losers’ including many people working in the public sector and is effectively increasing taxes on working people. Something the government have previously said they will not do.
We have also seen in the last few days reports of Chancellor Rachel Reeves planning to drop this idea due to the impact on the public sector.
Pension changes
The LCP report identifies three changes to the pension system that they believe are most likely based on the following criteria:
- The change would generate significant revenue for the government.
- It would primarily impact the wealthier.
- It could be implemented quickly.
- Does not disincentivise investing for retirement.
#1 – Reducing the pension tax free lump sum
I covered this in a recent video and this still seems like one the government could pursue.
Currently, when taking your pension benefits from a defined contribution scheme you are allowed to take up to 25% of the pot as a tax-free lump sum. This can be in one go or over a period of time.
Defined benefit pension scheme members can also take a tax-free lump sum when they take benefits, but it is slightly more complex in terms of how the tax-free cash lump is worked out.
There is already a cap on the total amount of tax-free lump sum a person can take over their lifetime. This is called the Lump Sum Allowance and is currently set at £268,275.
The report believes the most likely scenario is a reduction to the cap, say down to £100,000.
Reasons why the government may introduce this include:
- Not that many people have pension pots of the size that would mean reaching the Lump Sum Allowance so this change would mainly impact the wealthier.
- Relatively easy to implement although it would likely involve some form of transitional protection for people who were already over the new cap. Similar to what was done with the Lifetime Allowance.
Reasons against introducing this include:
- As it only impacts the wealthier the tax take would be less. The Institute for Fiscal Studies (IFS) estimate the total current cost of the pension tax free lump sum is around £5.5bn. So, if it only affects a small number of pots, the tax take would be low.
- The extra revenue wouldn’t come in immediately but instead over time as people most likely take more pension income that would be taxable over the course of their retirement.
- Defined benefit pensions and therefore public sector workers would be worse hit so not a group Labour are probably wanting to annoy.
#2 – Employer National Insurance contributions on employer pension contributions
Employers pay National Insurance on workers’ salary at a rate of 13.8%. However, if the employer makes pension contributions for the worker as part of their remuneration package, then they don’t pay National Insurance on the money used to make the contribution.
This saves employers quite a bit of money but as we have seen earlier, does cost the government £23.8bn a year in tax relief.
The potential change, which has been put forward by the Resolution Foundation and the IFS (thanks for that!) is that Employer National Insurance contributions should be paid on employer pension contributions.
Reasons why the government may introduce this include:
- It can be implemented quickly.
- Can raise a lot of money and straight away.
- The immediate hit is on businesses and not workers although workers may be hit in the long run with lower wages and/or things could cost more as businesses seek to recoup costs.
Reasons against introducing this include:
- It doesn’t really go with the government’s growth agenda as it’s taxing business more.
- It would impact public sector employers so it would actually cost the government to increase public sector budgets to cover the cost. This would bring down the net increase in government revenue from this change to around £16bn.
- It could impact defined benefit pensions that are underfunded as sometimes employers will pay big one-off contributions to a scheme to improve the funding position. They may not now have the resources to do this.
- Employers may reduce their pension contributions down to the minimum allowed which means people are saving less into pensions.
This potential change does tick a lot of boxes for the government and they could bring this change in a number of different ways to soften the immediate impact.
For example, they could bring in a new rate of employer National Insurance which initially starts off low and then increases over time. Or they could say that only a percentage of employer pension contributions are subject to National Insurance.
#3 – Taxing pension death benefits
The final area that LCP thinks is most under threat is the tax treatment of pension death benefits.
There are two different ways that the government could raise money here.
Currently, if you die before age 75, the beneficiaries of your pension can withdraw the entire pension tax free subject to the Lump Sum and Death Benefit Allowance. If you die after age 75 then your pension beneficiaries will pay Income Tax at their marginal rate on withdrawals from the pension pot.
The government could simply say that pensions inherited from someone who dies below age 75 are now taxable.
The second change the government could make is make all pension pots subject to Inheritance Tax on death. They are currently outside of your estate for Inheritance Tax purposes.
Reasons why the government may introduce these changes include:
- These measures mainly impact the wealthier.
- Relatively simple to implement.
Reasons against introducing the changes:
- Most people live past age 75 nowadays anyway so the extra tax intake is unlikely to be that much.
- Unfairly penalises defined contribution pension holders over defined benefit pension holders as defined benefit pensions only pay out an income to surviving spouse or civil partner so cannot be subject to Inheritance Tax.
- Although rising, Inheritance Tax is not a huge tax for the government. People could decide to gift parts of their pension to beneficiaries during their lifetime which whilst may increase Income Tax rates paid (via tax on pension withdrawals), the government may lose out on the extra Inheritance Tax.
If the government really is serious about raising funds, then it does look likely that something has to change on pensions due to the size of the numbers involved.
The three changes outlined above seem to offer the government the best way of doing this with some form of employer National Insurance of employer pension contributions the most obvious.
Of course, we still don’t know what’s going to happen for sure. At the moment the government seem to be rowing back on a lot of proposed changes once they hear about the political fallout.
Nowadays most politicians are weak and only interested in maintaining votes and their seat at the next election so part of me thinks they will dial everything down and make tweaks here and there.
The other part of me says that if they were going to do something drastic, now is the time to do it with it being their first Budget over a five-year term. So, plenty of time to deal with the fall out and generate more positive news.
In terms of what you should do, I would not be making any rash decisions. Only carry out the plans you were originally going to do anyway, regardless of the Budget.
Remember, any retirement plan should have the long term in mind so think about how your actions will impact the long term, not the short term.
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