Budget countdown: what if could mean for your pension

A tax grab is on the way, the government has warned, and savers’ pensions are expected to be on the chancellor’s hitlist.
Rachel Reeves is said to be considering a raid on savers’ pensions in next month’s budget as she comes under pressure to take away perks for wealthier savers, including tax relief for higher earners and inheritance tax exemptions on retirement pots. We look at four ways the government could take aim at your pension.
When you pay into a pension you get tax relief on your contributions at your income tax rate, either through a workplace pension where your contributions are taken from your gross salary before tax, or, with a personal pension, through a government top-up. A 20 per cent basic rate taxpayer who pays £80 into their personal pension, for example, will have their contribution topped up to £100 by the government.
In 2016, before she was shadow chancellor, Reeves suggested a flat rate of pension tax relief of 33 per cent — this would benefit basic-rate taxpayers but be a worse deal for higher and additional-rate taxpayers who get 40 per cent and 45 per cent tax relief respectively.
Over a whole career the change would be likely to benefit most workers, especially those at the beginning of their working life, but could cost higher-rate taxpayers £14,500 over 20 years on a typical £200-a-month pension contribution.
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Steven Cameron from the wealth manager Aegon said: “Previous chancellors have explored moving to a flat rate of relief for all. This would boost the income tax take, but would be very complex to implement, so should not be rushed in.”
The Institute for Fiscal Studies, a think tank, estimates that limiting the tax relief on pension contributions to 20 per cent could raise £15 billion a year for the government. “Higher and additional rate taxpayers concerned about losing out, and who plan to boost their pension pot in the future, could consider paying in more before the budget,” Cameron said.
The maximum annual contribution you can make while still getting tax relief is £60,000 (which includes the tax top-up). You cannot usually get tax relief on contributions of more than your salary, and the £60,000 limit is reduced for very high earners, who lose £1 for every £2 of “adjusted annual income” over £260,000 (which includes all pension contributions — yours and your employer’s).
You can usually take 25 per cent of your pension tax-free, up to a limit of £268,275, once you turn 55 (although this is rising to 57 from April 2028). The rest is normally liable to tax in the same way as any other income.
The tax-free lump sum is a valuable perk for anyone wanting to pay off a mortgage or make a big purchase in retirement, but the government is facing calls to cut the relief for those with the biggest pension pots.
“There is a possibility that the budget could either cap the tax-free lump sum at a much lower amount or reduce the proportion you can take to, say, 20 per cent. Both would increase the tax take,” Cameron said.
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The IFS estimates that a £100,000 cap on the tax-free lump sum would affect one in five pensions savers and could eventually raise about £2 billion a year for the government. Wealthier savers would lose out the most.
Cameron said: “To generate extra income tax, these changes would have to apply to pots already built up over years or decades. This would be highly controversial, reducing one of the most valued tax incentives that pension savers look forward to.
“If you were planning to take your tax-free lump sum soon anyway, it may be worth considering taking it before the budget. But taking money out of your pension before you need it is generally not a good idea because you will lose other tax benefits.”
Putting money into a pension is one of the most tax-efficient ways to save, and the perks continue after death. Most retirement pots can be passed on free of inheritance tax (IHT), which is levied at 40 per cent on other assets. Each estate gets an IHT-free allowance of £325,000 (£500,000 on most estates if a main home is left to a direct descendant).
Pensions have been excluded from estates for IHT purposes since 2015. Tom McPhail from the consultancy The Lang Cat said abolishing this perk was one of the most likely changes that Reeves could make on October 30. But this could encourage savers with big retirement pots to give away their wealth earlier, raising the risk that they will run out of funds later in life, when they may need to pay for care.
“A way around this could be a death tax on pensions that is charged at a lower rate than the IHT rate of 40 per cent. This way people would still be incentivised to keep money in their pension,” McPhail said.
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With workplace pensions, the tax and national insurance that you owe are calculated after pension contributions have been made. Employers also have to pay national insurance on workers’ salaries (at up to 13.8 per cent) but do not pay it on pension contributions. This relief could be targeted by the chancellor, McPhail said.
“I would be very surprised if they removed national insurance relief on pension contributions for employees because this would be seen as hitting workers directly. But removing it for employers is more likely,” he said.
He added, however, that this could “remove any incentive for employers to boost pension contributions for workers. They might be more inclined to channel the funds into higher pay instead, which might attract employees but would have a negative effect on retirement saving.”
A bumper payment into your pension before the budget could mitigate the impact of any tax changes, but is only advisable if you were already planning this.
“You don’t want to find that money being locked away if you need it later down the line. Investing a lump sum can also work against you in terms of market timing and risk, so it’s better to drip-feed funds where possible,” McPhail said.
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