Insiders say government officials admitted last week to being baffled by the scale of the fury caused by Labour’s decision to cut winter fuel payments. According to a Treasury source, ministers had “not taken into account how angry people would be”.
Faced with an angry army of retirees, industry insiders hope the Chancellor will be more alert to the strong emotions that come with changing people’s pensions.
But that won’t stop Rachel Reeves from touching pensions altogether. The consensus among the pensions industry is that they are too rich to be left untouched in the first Labor Budget. Half a dozen of Britain’s leading pensions experts who hold regular talks with Government and Treasury officials ahead of the budget agree: pensions are in the crosshairs.
But while there are rumors that the Chancellor could aim for a pension tax cut, several industry insiders tell us such a move looks increasingly unlikely.
We are told that the complexity involved would make it prohibitively complicated, raise less money for the Treasury than it might seem and simply not worth the fury it would create.
Rumors are swirling that Chancellor Rachel Reeves could focus on pension tax cuts in next months’ budget.
Wealth investigates why experts believe pension tax relief could live on to this day – and what could face being cut instead.
How does pension tax relief work?
You currently receive tax relief on any money you contribute to a pension at your marginal income tax rate. This means, for example, that a basic rate taxpayer gets 20 per cent tax relief on any money going into their pension, a higher rate taxpayer gets 40 per cent and an additional rate taxpayer 45 percent.
The total cost of tax relief to the Treasury last year was £48.7bn, so you can understand why some believe it is an obvious target for a Chancellor looking to save money.
The simplest way to soften tax relief would be to introduce a flat rate for everyone. Reeves has indicated he would consider a flat 30 percent relief rate. That would mean taxpayers with higher and additional rates would receive less. But to raise substantial amounts of cash, it would need to be set at 25 percent or as low as 20 percent, experts say.
Think tank Tax Policy Associates lists a reduction in pension tax relief as the most likely fiscal target in next month’s budget, while the Institute for Fiscal Studies estimates a move to a fixed rate could raise up to £15 billion a year.
Dan Neidle, founder of Tax Policy Associates, says, “I would say this is miles ahead of all other candidates for tax increases, given the large amounts that can be raised and the ease of implementation.”
Why there may be no change to tax relief
But ask any pensions expert worth their salt and they will tell you that a flat rate of pension tax reduction would be too complicated to implement.
Tom Selby, public policy director at stockbroker AJ Bell, says: “It’s a political and practical nightmare.” Lizzy Holliday, director of policy and public affairs at workplace pensions firm NOW: Pensions, agrees: “There would be a ton of unintended consequences.”
It would be easy to apply a flat rate of tax relief to the defined contributions paid by most private sector workers.
But for public sector workers it would be much more complicated and could lead to increases in their income tax. This is because these workers are promised a certain income when they retire based on their salary and length of service. The Government has to fulfill this promise.
But if these workers receive less each month in pension tax relief, that will create a shortfall in the amount saved for their pensions each year.
Pensions industry leaders we have spoken to agree that the only way to close the gap between the amount saved and the amount promised would be for workers to pay more income tax over their working lives.
As a result, millions of doctors, teachers, nurses and police officers would see a drop in their take-home pay. These are the same workers that the Labor Party has so desperately thrown money at through pay rises in recent weeks. The political capital that Sir Keir Starmer and Rachel Reeves have gained through their expensive and generous pay deals could be lost by such a move.
Pension industry leaders agree that the only way to close the gap between the amount saved and the amount promised would be for workers to pay more income taxes during their working lives.
Selby says: ‘We’re talking about imposing a huge tax burden on millions of workers. I don’t see a world where that doesn’t lead to walkouts and strikes by those working in the NHS, the police and teachers, especially.’
Neidle admits this is a big “trap” and would complicate any reform.
Steve Webb, former Pensions Minister and now partner at consultancy LCP, agrees: ‘Any changes to pension tax relief would take years to implement, so the Government would not see any savings for a long time. Public sector workers are the group that the Government obviously cares about and are the workers who would be affected by any reform.’
One option would be for Reeves to exclude public sector pensions. But that would defeat the point: most of the money the Government could save by reducing tax relief would come from the public sector, Selby says.
Public sector pensions already have a reputation for providing retirement income far more generous than private sector workers can dream of. Any other special treatment would simply serve to widen this chasm.
A source who until recently worked in policy at the Department for Work and Pensions says he would be surprised to see sweeping changes to tax relief without full consultation with the industry.
However, if you are a higher or additional rate taxpayer and are still worried about the prospects for tax and other reliefs, one option is to make the most of them now, before any potential changes. But it’s worth being sure that acting now would make sense in your own circumstances, whether or not the Chancellor makes any changes to pensions in the Budget, so you don’t feel remorse if she doesn’t go ahead.
What else could she do?
There are still plenty of other reliefs that experts say would be much easier for Reeves to achieve.
One of the pioneers is to make pension funds subject to inheritance tax, a change that experts say could be achieved overnight. Steven Cameron, of pensions firm Aegon, says one option would be to say the first £100,000 of pension savings is free of inheritance tax, but anything above this would trigger a 40 per cent tax bill.
Cutting the 25 percent lump sum of tax-free pensions could also be on the cards. Tax-free cash is one of the most attractive features of saving into a private pension. Currently, anyone over age 55 can withdraw the first 25 percent of their pot without incurring any tax liability.
Left-wing think tank Fabian Society says the Government could raise huge amounts of income by limiting the amount that can be withdrawn, tax-free, to £100,000. However, experts say this would not raise much money relative to the backlash it would provoke.
Another change that looks likely is a National Insurance tax on the contributions employers pay to workers’ pensions. Currently, employers pay national insurance with fair wages. Not charging employers for National Insurance pension contributions cost around £23.8 billion last year.
The Institute for Fiscal Studies says this “should be reformed.”
Robert Salter of the tax firm Blick Rothenberg says: “This seems to me the most likely change.”
But it warns that this could lead employers to cut the amount they pay into their workers’ pensions or affect future pay rises.
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