Exactly how Rachel Reeves pension tax raid could grab billions of our money

Chancellor Rachel Reeves is understood to be eyeing up the nation’s pensions in order to raise billions of pounds in her October budget.

Options on the table include a cap on tax free cash that can be taken out of pension pots, introducing inheritance tax on pension nest eggs, and changing the tax relief offered on contributions into workplace pensions.

Think tanks with close ties to Labour, together with respected bodies such as the Institute for Fiscal Studies, have identified how changes to the tax treatment of pensions could raise billions every year.

However, pension providers say any change to the rules that makes saving into a pension less attractive risks leaving millions suffering poverty in old age while at the same time reducing the money available to be invested in UK businesses, which is vital to boost the nation’s economic growth.

Experts at PensionBee, who manage £5.2 billion in assets on behalf of 252,000 customers, have identified the most likely changes to pensions and produced an assessment of the impact.

Putting a cap on tax-free cash

Currently, people can take 25 percent of their pension pot free of tax up to a limit of £268,275. However, there is speculation it could be cut to £100,000.

Becky O’Connor, Director of Public Affairs at PensionBee, said: “Despite the 25 percent tax-free lump sum on pension withdrawals being widely recognised as one of the most popular pension benefits, there is speculation the Chancellor may reduce this, or cap the amount.

“The £100,000 cap that has been rumoured would be a low threshold, and would mean that anyone with a total pension of £400,000 or more (roughly the amount that someone with a ‘moderate’ living standard in retirement would need) would be impacted. So a cut of this magnitude would negatively affect millions of middle income retirees, and would cause those on the cusp of retirement significant difficulty with decision-making.

“Less dramatic alternatives might include changing the percentage from 25 percent to say, 20 percent, or making a smaller change to the current lump sum allowance maximum of £268,275, which has been fixed at the same level despite the lifetime allowance being abolished and so now seems quite arbitrary.”

Changes to tax relief on pension contributions

Currently, basic rate taxpayers get tax relief at 20 percent on pension contributions. It is a higher 40 percent for those earning £50,271 to £125,140 and 45 percent for those above this figure.

It is suggested there should be a flat rate of tax relief at 30 percent, which would be good news for the majority of workers but would hit the pension pots of high earners.

Becky O’Connor said: “The introduction of a 30 percent flat rate of tax relief on pension contributions has long been rumoured and it's now time to grab the bull by its horns.

“A flat rate could create a simpler, more uniform approach to pension tax relief, offering a significant advantage to millions of basic rate and non taxpayers - notably lower income earners (the younger and women) - by encouraging them and enabling them to accumulate greater pension wealth with an extra Government top-up every time they contributed into their pension.

“While higher and additional rate taxpayers would receive less in pension tax relief compared to what they receive under the current system, pension contribution tax advantages in general remain generous compared to those available in other savings vehicles.

“A simpler approach to tax relief could eliminate the need for complex self-assessment tax rebates for higher and additional rate taxpayers, a process many forget or are unaware of. In addition, more of the tax relief would go directly into their pensions rather than their bank accounts, making the process more straightforward, potentially more lucrative and ensuring all pension savers equally benefit from the available relief.”

Pensions being subject to inheritance tax

Currently, people who die before the age of 75 can pass on their pension pot to loved ones free of inheritance tax. There is speculation that this tax break could be scrapped.

Becky O’Connor said: “Bringing defined contribution pensions into someone’s estate for inheritance tax purposes would remove a key advantage that pensions have over other forms of long-term investment for those who are focused on tax efficiency.

“Income tax is already due on pension income for those who pass away after the age of 75, so making pensions liable for inheritance tax too could start to make them less attractive from a planning point of view and potentially dissuade people from saving into them.

“Our own research indicates that this change wouldn’t be very popular amongst savers, with 51 percent expressing that they plan to, or already have moved money into their pension to reduce the size of their estate. Instead, a significant proportion of savers (60 percent) stated that they’d prefer if inheritance tax was scrapped altogether.”

Removing National Insurance relief on pension contributions

Currently both employers and employees benefit from not having to pay National Insurance on pension contributions. It is possible that this exemption could be scrapped, either just for employers or for both employers and workers.

Becky O’Connor said: “Altering the way National Insurance is levied on pension contributions may raise revenue, but it could have the negative consequence of making employers less generous in their pension offers to employees.”

Reducing the Annual Allowance                                  

Currently, people can pay up to £60,000 a year from their salary into their pension, which accrues tax relief. However, this cap could be reduced.

Becky O’Connor said: “Unravelling beneficial tax incentives such as the higher Annual Allowance would neither be helpful to savers, nor much of a revenue raiser for the Government, as the majority of people do not come close to even the former £40,000 maximum amount each year.”

Re-introducing the Lifetime Allowance

The Lifetime Allowance put a cap on how much could be accrued in a pension pot of £1,073,100 before punitive tax penalty charges were applied. The LTA was scrapped in April this year. However, Labour could bring it back.

Becky O’Connor said: “The uncertainty surrounding this decision can make it challenging for pension savers to plan ahead. Individuals approaching retirement age might feel compelled to withdraw any savings exceeding the previous limit to avoid potential tax penalties.

“Those close to breaching the previous allowance threshold and several years off from retirement, could consider a prudent approach may be to wait and assess the impact of any policy changes. It is unlikely that any reforms would be implemented immediately, so affected savers may not need to rush into making a decision.”

Change the rules on automatic enrolment into workplace pension schemes

Currently, the age at which workers are automatically enrolled into workplace pension schemes is 22. However, it is thought it is highly likely that this will be reduced to 18.

An update is due on the introduction of the extension of automatic enrolment, to include reducing the age of auto enrolment from 22 to 18 and removing the lower level of qualifying earnings.

Becky O’Connor said: “Legislation enabling the extension of automatic enrolment was passed a year ago, however we await the introduction of the key measures that would help to boost people’s pension pots.

“A follow-up announcement on this is due and it could make sense for the Government to mention it in the upcoming Budget alongside any updates on the Pension Investment Review, to give reassurance that savers’ retirement outcomes are being prioritised and to provide employers with clarity for planning purposes.”