With interest in Angela Rayner’s tax affairs ebbing away, the focus has swung firmly towards the Chancellor’s upcoming Budget – and the plans she has to tax our hard-earned wealth.
A tax attack on our pensions, it seems, is a virtual given.
‘Reeves’s Budget is shaping up to be another exercise in tax-raising,’ warns James Scott-Hopkins, founder of financial planning firm EXE Capital Management. ‘Pensions are highly likely to be in the firing line.’
According to financial experts such as Mr Scott-Hopkins, the assault could take three forms.
We might see the right to tax-free cash from our pension pot restricted, the tax relief curbed on the money that we pour into our pension pots, and a clampdown on work pensions set up to mitigate tax for both employees and employers (so-called salary sacrifice arrangements).
While it’s possible that Chancellor Rachel Reeves may launch a three-pronged attack, it’s more likely she will opt to introduce ‘just’ one of these measures to begin with.
Retirement raid: Experts believe Chancellor Rachel Reeves (pictured) could launch a three-pronged assault on the nation’s pension savings
The experts’ money is on a reduction in the 40 and 45 per cent tax relief that higher and additional-rate taxpayers respectively enjoy on contributions (and those made on their behalf by employers).
A move that would generate big savings, but impair the ability of millions of workers to build a pension pot large enough to see them financially secure in later life.
Crazy? Yes. Possible? Absolutely. Here, we spell out why reform of pension tax relief could be coming our way.
We also look at the challenges Labour will face implementing such a reform, while spelling out the measures you can take now to boost your pension ahead of any change.
Six reason tax relief reform is imminent
1. Labour has boxed itself in when it comes to raising the £50billion required to balance the nation’s books. A manifesto pledge not to raise VAT, income tax and national insurance (NI) rates for workers means the Chancellor has to look elsewhere for extra tax revenue or savings.
This situation has been exacerbated by the Government’s inability to get a grip of its grandiose spending plans.
Having stung business last year with steep increases in NI bills, Ms Reeves dare not go back for more. It would destroy any chance she has of getting the economy into growth mode.
So, she has no choice but to look at our wealth – and our ability to accumulate it – and see what savings she can make and what extra taxes she can impose. Restricting tax relief on pension contributions is an obvious money saver.
2. Tax relief on pension contributions costs the Exchequer some £50billion net a year. By net, I mean the amount it pays out in tax relief, minus the tax it receives on the income (or withdrawals) that people take from their pensions in later life.
A report from pension expert LCP says the introduction of a flat 20 per cent rate of relief would save the Exchequer at least £15billion a year.
Equivalent to not far short of a third of the ‘black hole’ in the nation’s finances. A tempting – almost irresistible – saving for a Chancellor keen to show financial markets she can run a tight ship.
3. Ahead of last year’s Budget, the Chancellor quickly ruled out a reduction in pension tax relief for higher-rate taxpayers.
Some experts now believe this could have been a ploy to give Treasury boffins more time to work out how to introduce it (for example, getting the level of the flat rate right) and to keep the public on its side.
So far, the Treasury has yet to rule out Budget changes to pension tax breaks.
4. The appointment of Torsten Bell to help the Chancellor prepare November’s Budget ratchets up the likelihood of pension reform.
During Bell’s time as boss of Resolution Foundation, the economic think-tank regularly referred to the unfairness of the pension tax relief regime, which benefited high earners the most. November 26 could be when this ‘unfairness’ starts to be unwound.
5. Introducing a flat rate of tax relief would go down well with Labour MPs, particularly those on the Left of the party.
This would especially be the case if the flat rate was set at 30 per cent, boosting the contributions of basic rate taxpayers while cutting tax relief for high earners.
6. In defending its introduction, Ms Reeves could argue that Conservative Chancellor George Osborne contemplated doing something similar in his 2016 Budget, only to get cold feet.
A flat rate of relief was one of two reforms he mulled over. The other was to scrap tax relief altogether, but in return make all pension pot withdrawals tax-free.
In the end, a campaign spearheaded by Money Mail persuaded Mr Osborne to change his mind.
Squeeze: A reduction in tax relief that higher-rate taxpayers enjoy would impair the ability of millions of workers to build a pot large enough to see them financially secure in later life
How would a flat rate hit you?
Money Mail asked wealth manager Evelyn Partners to look at how the introduction of a flat rate of tax relief would impact on our ability to build a pension fund.
It looked at how the pension pot of a basic, higher, and additional-rate taxpayer would benefit or suffer in the future if a 30 per cent rate of tax relief was introduced.
The analysis was full of assumptions. For example, Evelyn did its calculations based on annual pension contributions of 8 per cent and investment returns averaging 6 per cent. But the results were startling.
For a 25-year-old basic-rate taxpayer earning £28,000, their pension pot under the current tax relief regime would grow from scratch to £346,660 by age 65.
But with 30 per cent tax relief, it would be boosted by an additional £34,670, taking it to £381,330. Higher and additional rate taxpayers, however, would be hit hard.
A higher-rate taxpayer earning £55,000 would see their pension pot at age 65 diminished by £68,102, from £680,952 to £612,850.
For an additional-rate taxpayer earning £130,000, their pot would come tumbling down by £284,450: from £1,609,520 to £1,325,070.
Andrew King, Evelyn’s retirement planning specialist, crunched the numbers.
He says: ‘A 30 per cent rate of tax relief could be sold as handing a pension bonus to basic-rate taxpayers.
‘But it wouldn’t bring a huge amount into the Treasury coffers as the savings from abolishing 40 and 45 per cent relief would be mitigated by the added tax break given to basic-rate taxpayers.’
He adds: ‘To generate meaningful tax savings, tax relief would need to be carved back to 20 per cent, which would prove deeply unpopular with the ballooning number of voters paying higher rates of tax.
‘In addition, it would be seen by younger savers as yet another example of inter-generational unfairness. They would lose the right to a higher rate of relief on their pension payments as they move from basic to higher rate taxpayers.’
Mr King also says a flat rate of relief would be vehemently opposed by high earners in the public sector as a result of the substantial amount of tax relief they would lose on contributions (especially those made by employers on their behalf) into deluxe defined-benefit pension schemes.
Jon Hickman, tax partner at accountancy firm BDO, says any reduction in tax relief would ‘deter higher earners from saving for retirement’.
Disastrous given the country is already in the midst of a chronic retirement crisis.
How to protect your pension
There are steps you can take to keep your pension on track if flat-rate tax relief heads our way.
1. Ahead of the Budget, higher-rate taxpayers should consider increasing their pension contributions – or making a one-off payment – to take advantage of the current tax relief regime.
Even if no changes are announced on November 26, the bigger payments made will still boost the size of your final pension pot.
The current ‘annual allowance’ rules allow you to contribute a maximum of £60,000 in the current tax year into your pension – or up to 100 per cent of your annual earnings if they are lower than £60,000.
The allowance includes employer contributions and all payments made within it enjoy tax relief. Really high earners may be subject to a lower annual allowance (take advice).
If you have maxed out this tax year’s allowance, you can use any unused allowance from the previous three tax years to boost your pension payments further.
This is known as ‘carry forward’. It’s complicated, so again seek professional advice.
2. If you are a basic-rate taxpayer, it is probably best to defer any big lump sum payment into your pension until after the Budget – just in case a 30 per cent flat rate of relief is announced.
But don’t stop your regular pension contributions. Keep on building your pension.
3. Don’t forget to think about your children when it comes to pensions. You can put £2,880 into a pension for a child each year (until age 18) and the government will top it up with 20 per cent tax relief worth £720.
Maybe 30 per cent if a 30 per cent flat rate of tax relief on contributions is announced on November 26.
jeff.prestridge@dailymail.co.uk
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