Could Labour potentially alter the tax benefits related to pensions?
The upcoming Labour Budget, expected to be a challenging one with "painful" decisions, may see changes to the current pension system. One of the speculated changes is a review of pension tax relief, particularly for higher earners. However, implementing such a change isn't straightforward, as many pension schemes are structured in a way that would require a tax charge to reduce the relief for higher earners.
Under the current rules, savers are entitled to tax relief on money they pay into their pension pot, with basic-rate taxpayers receiving 20%, higher-rate taxpayers getting 40%, and additional-rate taxpayers receiving 45%. In 2022/23, pension tax relief cost the government £48.7 billion, with almost two-thirds of this sum enjoyed by higher and additional-rate taxpayers.
If the government decides to cut pension tax relief for higher earners, one option could be to introduce a flat rate of relief for all savers, say 30%. In "net pay" schemes, the only way for the government to reduce the amount of relief for higher earners would be to apply a tax charge. For instance, if a higher-rate taxpayer had paid a £10,000 contribution to a net pay scheme in the tax year, they would presumably need to pay a £1,000 tax charge to reduce their tax relief to the required 30%.
However, such a change may prove unpopular and risk alienating public sector workers on final salary pension schemes, among others. In light of this, Labour is considering several alternative options to cutting pension tax relief for higher earners, including:
- Raising the state retirement age further to reduce pension costs, possibly with flexible or reduced state pensions available at earlier ages.
- Increasing mandatory private pension contributions by requiring more people to save into private pensions, potentially offsetting state pension costs and encouraging more personal retirement savings.
- Means-testing the state pension for those with private pensions, which could reduce state obligations for wealthier retirees without directly altering tax relief on pensions.
- Modifying inheritance tax rules on pensions, as the government is moving to bring most pension savings within the scope of inheritance tax by 2027. Labour could explore re-shaping inheritance tax on pension savings to protect revenues without cutting relief upfront.
- Reinstating or adjusting the lifetime allowance for pension contributions, which restricts the total tax-privileged pension savings individuals can accumulate.
- Reviewing or abolishing pension salary sacrifice arrangements, which have recently come under HMRC scrutiny.
- Increasing taxes elsewhere, such as employer national insurance contributions.
These alternatives might generate needed revenue and address structural pension system issues while avoiding the potentially unpopular step of cutting higher earners' pension tax relief, which may discourage retirement saving and complicate pension scheme administration.
Recently, The Times reported that Labour is expected to abandon its plans to cut pension tax relief due to concerns it would impact public sector workers on "relatively modest incomes." The government has also recently offered public sector workers a pay rise in an attempt to end industrial action, and a rule change in pension tax relief could be counterintuitive given this context.
In conclusion, the Labour Budget is expected to bring changes to the pension system, with potential adjustments to pension tax relief for higher earners being one of the speculated changes. However, the final decisions are yet to be announced, and the government is considering several alternative options to achieve its revenue goals while maintaining the incentive for retirement savings.
- The upcoming Labour Budget suggests potential changes to the current pension system, with a review of pension tax relief for higher earners being one of the speculated adjustments.
- If the government decides to cut pension tax relief for higher earners, one option could be to introduce a flat rate of relief for all savers, such as 30%.
- The Labour Budget may see the exploration of alternative options to cutting pension tax relief for higher earners, including raising the state retirement age, increasing mandatory private pension contributions, means-testing the state pension, modifying inheritance tax rules on pensions, and reviewing pension salary sacrifice arrangements.
- There are concerns that cutting pension tax relief would impact public sector workers on "relatively modest incomes," and the government has recently offered them a pay rise to end industrial action, which might make a rule change in pension tax relief counterintuitive.
