Will pensions be in the firing line as Reeves looks to plug £40bn hole in finances?

Experts believe the Chancellor could look at pension tax relief in her autumn Budget

In our weekly series, readers can email in with any question about retirement and pension savings to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he does not know about pensions. If you have a question for him, email us at money@inews.co.uk.

Question: Given the Chancellor now needs to raise somewhere between £40bn and £50bn at the Budget to meet her fiscal rules, I’m worried she might come for my pension. Should I be?

Answer: Nobody can be sure what is going to be in the Budget – including, in all likelihood, Rachel Reeves. Indeed, we don’t even know when it will be held, although most are expecting the Chancellor to deliver her annual round of tax and spend announcements in October or November.

However, given the parlous state of the nation’s finances – driven largely by slower than expected economic growth – tax rises, spending cuts or an adjustment to the Treasury’s borrowing rules will almost certainly be necessary.

As the latter has been repeatedly ruled out by ministers, and departmental spending settlements were set out in the Spring Statement, tax rises feel all but inevitable.

Furthermore, with the Government continuing to insist its manifesto pledge not to raise the rates of income tax, national insurance (NI) or VAT on “working people” will not be breached – and having already hit employers with a £25bn NI hike in the last Budget – options that will raise the cash required are thin on the ground.

Against this backdrop, speculation about retirement savings incentives will likely hit fever pitch in the coming months, just as they did before Reeves’ 2024 Budget.

Before I run through some of the options she might consider – and why each is likely to be either unpopular or ineffective – the most important thing to do is not react to this speculation.

You can only deal with the tax rules as you find them, and trying to second-guess political announcements that are, by their nature, entirely uncertain can lead to irreversible financial mistakes.

With that said, the pensions rumours that usually do the rounds ahead of major fiscal events centre on the two big tax incentives – upfront tax relief on contributions and people’s tax-free cash entitlements when they access their pension. Let’s take these in turn.

Reform to pensions tax relief

As things stand, you are entitled to income tax relief on your pension contributions, meaning a 20 per cent taxpayer gets 20 per cent relief and a 40 per cent taxpayer gets 40 per cent relief.

In practical terms, this means if you pay £80 into a pension, this will automatically be turned into £100 through tax relief, with higher-rate taxpayers entitled to an extra £20, meaning getting £100 in their pension will only cost £60.

In some schemes, you will get all your tax relief automatically, while in others you will need to claim higher or additional-rate tax relief from HMRC.

Commentators often suggest the Government should shift this to a flat rate of tax relief set somewhere between 20 per cent and 40 per cent, arguing that this would be fairer and could raise cash for the Exchequer at the same time.

However, going down this road would require a flat rate to be introduced across both defined contribution (DC) and defined benefit (DB) schemes – the latter of which reside primarily in the public sector.

Because DB schemes provide full tax relief automatically (along with some DC schemes), introducing a flat rate below 40 per cent would require a tax charge to be levied on every public sector DB member paying higher rate income tax (i.e. earning more than £50,270).

Such a move would likely go down like a cup of cold sick with those affected, including doctors in the NHS, meaning it is a politically extremely unpalatable option.

Alternatively, the Government could reduce the annual allowance – the maximum total contribution that can be made to a pension each year – from £60,000 or even reintroduce the lifetime allowance.

However, given it was senior NHS staff who successfully lobbied for the former to be increased and the latter to be scrapped altogether, going back on this would also risk further unrest.

Reducing tax-free cash entitlements

Under current rules, you can access up to a quarter of your pension tax-free from age 55, with this minimum access age due to rise to age 57 in 2028. The maximum tax-free cash most people can take over their lifetime is capped at £268,275. One money-saving option often floated is to reduce this figure to, say, £100,000.

While this might sound straightforward, the Government would almost certainly need to provide protection for people who have already built up tax-free cash entitlements in excess of any new lower figure, meaning savings to the Treasury would likely be relatively small, at least in the short term.

It would also add huge uncertainty to pensions at a time when the Government says it is focused on delivering retirement adequacy for millions of Brits.

Rather than allow these sorts of rumours to fester, AJ Bell has campaigned for a Pensions Tax Lock – a commitment from the Government not to change tax relief or tax-free cash, at least for the rest of this Parliament.

But in the meantime, I’d strongly urge you to ignore the inevitable speculation and focus on your long-term retirement goals.