Rumours about what could be in Labour’s first Budget for 14 years have been picking up for weeks with many worried about the changes Rachel Reeves could make to people’s pensions.
Since Sir Keir Starmer warned that the fiscal event would be “painful”, the assumption has been that tax rises in some form will be coming.
And in recent weeks, think tanks have begun to make suggestions for what changes Labour could make.
Below, we run through the potential changes the Chancellor could make to pensions next month.
Changes to tax relief on pension contributions
Contributions to pensions currently benefit from tax relief at a “marginal rate”, meaning basic rate taxpayers get 20 per cent, higher-rate taxpayers 40 per cent and additional-rate taxpayers 45 per cent.
This means that paying into a pension saves people on their tax bills.
Earlier this summer, it was widely reported that the Chancellor would be urged by Treasury officials to consider introducing a flat 30 per cent rate of tax relief.
It would mean higher rate payers, those earning over £50,271, will pay an effective 10 per cent tax charge on their pension and the current tiered rate of pension tax relief would be merged into a new flat rate of either 20 per cent or 30 per cent.
For basic rate taxpayers, a £100 contribution would cost them £70 rather than £80.
However, it would mean that higher-rate tax payers would pay more.
Annual statistics published in July by HMRC showed that the cost to the Exchequer of the income tax and national insurance reliefs on pensions came to £48.7bn between April 2022 and April 2023, up £1.1bn on a year prior.
Ex-pensions minister Sir Steve Webb said at the time: “There is no doubt that the Chancellor will be eyeing up the large price tag attached to providing tax and national insurance relief on pension contributions.”
Reduction in the pension tax-free lump sum
Currently, retirees can take 25 per cent of their pension pot savings tax-free, up to the value of £268,275, when they retire.
The Institute for Fiscal Studies (IFS) has said it could be capped at £100,000 instead.
As a result of some of the speculation, there has been an increase in the number of people contacting financial planners to see if they should cash in lump sums from their pension before next month’s Budget amid worries of a potential tax raid.
But experts have said they think a change in this area is less likely than to tax relief.
“If they are doing something on pension tax it’s more likely to be on tax relief on contributions into pensions, I can’t see them doing anything on the lump sum,” said David Gibb, a chartered financial planner at Quilter Cheviot.
Changes to inheritance tax rules regarding pensions
When people pass away, the beneficiary of their “estate” – which essentially means their assets – may have to pay tax on what they inherit.
However, pensions generally sit outside of a person’s estate for inheritance tax purposes.
It can depend on whether you have a defined contribution or defined benefit pension pot.
A defined benefit pension, also known as a final salary scheme, guarantees a specific income upon retirement. It is typically provided by employers as part of an employment package.
On the other hand, a defined contribution pension is an individual savings-based scheme. Under this arrangement, both the employee and often the employer make contributions into a personal pension pot.
Full rules can be seen in the table below.
A change to inheritance tax rules on pensions is also something that has also been called for by the IFS.
“Pension pots should be included in the value of estates at death for the purposes of inheritance tax. If we are to have an inheritance tax, it should apply evenly across all forms of wealth,” it had previously said in a paper on the topic.
Update on the increase to the state pension
In better news, the Chancellor is expected to confirm an increase to the state pension from next April.
Under the triple lock, the state pension increases every April by whatever is the highest – inflation, earnings growth or 2.5 per cent – and this year the earnings growth figure is expected to be the highest of the three.
Earnings data for May to July stood at 4 per cent, so is virtually certain to be higher than inflation, and used to uprate the state pension.
But the decision still needs to be confirmed, which is expected at the upcoming Budget.
The current new state pension, received by those who reached state pension age after 6 April 2016, is £221.20 per week, and if it were to increase by 4 per cent, would rise to £230.05 – as the figure is always rounded up to the nearest 5p. Over a year, this would equate to £11,962.60, up from £11,502.40.
