That the government is in a very difficult financial position is beyond doubt, although opinions may vary over the extent to which its predicament is self-inflicted.
They need money to meet their spending plans and having ruled out taxes on “working people”, there are few options open to them. The budget is due in a few weeks. They need to find about £50 billion.
Enter stage left Torsten Bell, now tasked with helping Rachel Reeves to write her budget. I think our pensions are high on his list of targets.
The UK pension system holds trillions of pounds of capital and every year the government grants pension tax relief of about £70 billion, disproportionately to higher earners.
In his recent bestselling book, Bell speaks at length about the iniquitous disparity of tax treatment of differing sources of income, in particular investment income.
He argues in favour of inheritance tax on pensions and has defended the imposition of tax on family farms with the zeal and gusto of a true believer. This is a man for whom the taxation of wealth is not so much a job as a calling in life.
In this context, it would be genuinely surprising to me if we didn’t see some kind of tax raid(s) on our pensions. So what could that look like?
There’s the right to take a tax-free lump sum at retirement. The limit is set at £268,725 or 25 per cent of your pension savings, whichever is the lower. Bell, who is no great fan of the accumulation of private wealth when there are public services to be paid for, has argued in favour of slashing this allowance to £40,000.
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According to the Institute for Fiscal Studies (IFS), a long-standing independent research body that also supports a reduction, the lump sum allowance costs the Treasury £5 billion a year. Limiting it to £100,000 would generate savings of £2 billion a year.
An added attraction (politically, at least) of this move is that it is simple to implement. It could be achieved with minimal legislative change and without any significant administrative consequences.
Obviously, it would upset a lot of Gen X voters who are approaching retirement, but they are baby-boomer-adjacent and as such the present government may regard them as electorally a lost cause already.
Tax relief is also granted on contributions made at the front end of pension saving. The rate and amount of relief granted depends on the tax status of the individual; higher rate taxpayers enjoy a higher rate of tax relief because they pay more tax.
The government might limit future tax relief to the basic rate. About £16 billion of pension tax relief is specifically in relation to higher rates of income tax, so abolishing that would not only be progressive in terms of levelling the playing field between lower and higher earners, it would also save the Treasury some serious cash.
The downside to doing this, other than upsetting the millions of people who pay higher rate tax, growing in number every year thanks to fiscal drag, is that it would be technically complicated and messy to implement. Still, £16 billion is tempting.
A further possibility to consider is the imposition of National Insurance on pension income. Income generated from capital, whether the realisation of capital gains on investments, or the drawdown of retirement savings in a pension arrangement are definitely fair game for this government.
No working people being harmed here, they would say, just levelling the playing field between workers and wealthy pensioners.
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Everyone has to pay their fair share in support of public services. Employee National Insurance is 8 per cent, so a cut in pensioners’ income of that magnitude is probably beyond the pale. But it could be introduced progressively, starting with higher incomes. Once the principle has been established, the dial could be turned up over subsequent years.
Sticking with National Insurance, the abolition of NI relief on employers’ pension contributions is one of those technical adjustments that none but financial journalists and payroll managers would get excited about. Which is lucky for the government because it could raise another £12-13 billion.
Like the increase in employers’ NI last year, this measure would impact employees indirectly, rather than directly. It would force up the cost of employment and the cost of pension funding, leading inevitably to a decline in both.
Again, the IFS has also advocated such a measure in the past, so it isn’t beyond the bounds of possibility.
To be fair to Bell, in his book he makes a number of sensible arguments for fiscal reform and for greater coherence and consistency, not just in how much tax is raised but also how it is raised. The challenge for him and Reeves is how they plug the holes in their budget without ruining our retirements in the process.
Finally, we have been here before, in terms of pre-budget pensions speculation and while I think all these threats are real, none is certain. With pensions, some decisions, once taken, can be impossible to unwind. So I would encourage you to speak to a financial adviser before acting in haste before the budget.
Tom McPhail has nearly 40 years’ experience in the pensions industry and was the head of retirement policy at the investment firm Hargreaves Lansdown