A number of popular relief schemes, including the 25 per cent tax-free lump sum, that encourage workers to save for retirement could be slashed come October
Rachel Reeves is facing a summer of speculation over tax rises ahead of her Autumn Budget, and experts believe pensions could be in the firing line.
Several tax changes – that would hit millions of savers and workers, including higher earners and those relying on their retirement pots for long-term financial security – could be on the cards, experts warn.
“There is a rather uneasy sense of déjà vu simmering. The rumour mill concerning pension tax spun into a frenzy last autumn, and it seems we’re gearing up for round two,” said Craig Rickman, personal finance editor at interactive investor.
He urged caution, warning that any move to limit the incentives around pensions could have long-term consequences.
So, what changes could be made come October and how would they hit your retirement fund?
Changes to tax relief on contributions could cost some workers £600 a year
At the centre of the speculation is a shift from the current system of pensions tax relief.
Contributors to pensions currently benefit from tax relief at a “marginal rate”, meaning basic rate taxpayers – those earning between £12,570 to £50,270 – get 20 per cent, higher rate taxpayers – those earning £50,270 to £125,140 – 40 per cent and additional rate taxpayers – those earning more – 45 per cent.
Pension tax relief has long been seen as vulnerable to reform. Cuts to the tax relief that higher earners enjoy on pension contributions are “inevitable” in the next three to four years, former Tory pensions minister Guy Opperman said earlier this year.
One option that has been floated is a flat rate of either 25 per cent or 30 per cent.
That would mean basic rate taxpayers could gain slightly, but the other two higher rate taxpayers would lose hundreds of pounds a year in tax relief.
Rickman explained: “Under a 30 per cent flat-rate system, a 40 per cent taxpayer earning £60,000 who personally contributes 10 per cent into a pension annually would be £600 a year worse off, while a 20 per cent taxpayer earning £35,000 contributing the same percentage would be £350 a year better off.”
Zoe Dagless, a financial adviser at Meliora Financial Planning, said the shift would hit a group she describes as the “sticky middle” – those earning above £50,000 who are trying to save consistently but would lose valuable incentives.
Salary sacrifice and employer national insurance relief changes could mean less generous pensions
Another key area under review is salary sacrifice. This is a popular method of boosting pension contributions while reducing both income tax and national insurance (NI).
For many, it makes pension saving significantly more efficient.
Employees can reduce their NI contributions and benefit from tax relief on the money they put in their pension.
Employers don’t pay NI on money they pay into their staff members’ pensions, and also reduce their bills further because their employees reduce their salary.
Although employers have to pay NI on wages – with the rate rising from 13.8 per cent to 15 per cent in April – they do not on pensions.
Employers currently have to auto-enrol most employees into a pension scheme and pay in 3 per cent, with employees paying 5 per cent, but some employers offer to pay more if their employees agree to pay more.
For example, some will match their employees contributions up to 8 per cent.
Financial planners say removing that relief could discourage firms from offering generous pensions
“Without that incentive, we could see the standard level of employer pension contributions fall, further widening the pension gap at retirement,” said Dagless.
Former Tory pensions minister, Baroness Altmann, said such a change would be costly and hard to roll out quickly.
She explained: “Ending NI employer relief would end salary sacrifice too and this change would cost employers huge sums as well as being an administration nightmare. It could not be implemented quickly.”
Tax-free lump sum changes could cost some big savers £10,000
Perhaps the most politically sensitive reform is cutting the 25 per cent tax-free lump sum.
Currently, savers can withdraw 25 per cent of their pension – up to £268,275 – without paying tax.
One option previously proposed by the Institute for Fiscal Studies think-tank is reducing that threshold to £100,000 – a move that would increase tax bills in retirement for many.
Altmann said this benefit is one of the key reasons people contribute to pensions in the first place, adding: “Restricting or reducing the tax-free lump sum would undermine confidence in pensions significantly.
“If existing pensions are hit, then it is another retrospective tax change.”
For a basic rate taxpayer, paying 20 per cent tax on an extra £168,275 could mean them paying an extra £33,653 in tax across their entire retirement.
The uncertainty makes planning impossible
The bigger issue for many financial advisers is not just what changes might come, but the damage done by the constant speculation.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “Pensions are a long-term game and a long-term approach to them is needed. Tinkering with tax rules undermines confidence in the system and creates complexity that makes people hesitant to save.”
She warned that rumours over the tax-free lump sum last year even led people to take money out of their pension early, worried the benefit would be removed.
Morrissey added: “It can lead to really poor outcomes. You could even fall foul of pension recycling rules or end up parking the money in an account earning poor interest.”
A spokesperson for the Treasury said: “As set out in the Plan for Change, the best way to strengthen public finances is by growing the economy – which is our focus. Changes to tax and spend policy are not the only ways of doing this, as seen with our planning reforms, which are expected to grow the economy by £6.8bn and cut borrowing by £3.4bn.
“We are committed to keeping taxes for working people as low as possible, which is why at last autumn’s Budget, we protected working people’s payslips and kept our promise not to raise the basic, higher or additional rates of income tax, employee national insurancee, or VAT.”