It’s Halloween, and as Budget speculation reaches fever pitch, advisers are bracing for potential shocks lurking in Rachel Reeves’ Red Box. In this week’s Friday Focus, Aegon UK’s Pensions Director, Steven Cameron, considers whether pensions could be in line for a trick or a treat at the hands of the Chancellor in a few weeks’ time.
After the longest build up ever to a Budget, the anticipation is high regarding what could make it into Rachel Reeves’ Budget Red Box. If the constant speculation is anything to go by, there’s plenty to pick and mix from. Advisers face the challenge of navigating any fallout, with clients being bombarded with ‘what if’ stories across the national media, some of which might prompt ‘just in case’ actions they may later regret.
Stepping back
It may be helpful to step back and look at the drivers behind the Chancellor’s forthcoming decisions. The repeatedly emphasised top priority is improving UK economic growth. Alongside this is the crucial need to demonstrate fiscal prudence and not ‘spook the markets. Another consistent theme is the commitment to support ‘working people’, although this group has yet to be clearly defined. Additionally, there’s the principle of asking those with ‘broader shoulders’ to bear a larger share of the burden.
The changing pensions landscape
So, what might this mean for pensions and their tax treatment? Let’s not forget the pensions world is already facing radical change, much of which is strongly aligned with the Government’s UK growth agenda.
The wide-ranging Pension Schemes Bill includes many initiatives to channel more pension investments into private assets, including within the UK. The Government’s support for Collective Defined Contribution schemes also ties into that investment agenda. With pensions positioned as part of the solution, not the problem, surely it doesn’t make sense to make damaging changes in pensions tax treatment?
We’re still in the midst of discussions around how to implement last year’s Budget’s pension surprise – bringing unused pensions on death into scope of inheritance tax. The rationale was to encourage pensions, with their tax incentives, to serve their intended purpose – to provide an income in retirement.
However, what may have seemed like a simple announcement has been anything but simple to execute, with both industry and HMRC struggling to find a practical solution. We faced similar challenges with the previous Government’s removal of the Lifetime Allowance in their last Budget. While pulling a pensions rabbit out of the Budget hat might be tempting, proper advance consultations with industry and HMRC could really be the trick to achieving a successful outcome!
The options for pensions tax reform
Speculating on possible changes to pensions tax relief is now an established part of the pre-Budget run-up. But the more intense it gets, the more damaging it can be if individuals jump to make snap decisions that they may live to regret. I’m not going to speculate here but instead, run through the options and their possible consequences, good or (more often) bad.
Reducing the tax-free cash lump sum
This has been at the forefront of pre-Budget speculation, both this year and last. We now know that those who take their tax-free cash can’t simply change their mind and ‘cancel’ the decision, for example if Budget fears prove unfounded. This may deter some from taking pre-emptive action this year.
What some consumer press headlines may not make clear is that reducing the maximum from the current £268,275 to, say, £100,000 would only affect those with projected pension pots exceeding £400,000.
The big question is: would the Chancellor implement rule changes with retrospective effect? Historically, Governments have not taken such an approach, as it would penalise those who’ve saved for decades on the clear understanding that 25% of their pension pot can be taken as a tax-free lump sum. If any change is made, conventions would point to individuals being able to apply for ‘protections’, although this would reduce any immediate tax boost for the Treasury.
But as the saying goes, desperate times can lead to desperate measures. How desperate is the Chancellor currently feeling? And how wildly unpopular would this change be, including to those with generous public sector defined benefit pensions?
Annual and lifetime allowances
It’s fair to say that most ‘working people’ probably don’t use up their full £60,000 pensions annual allowance each year. However, a cut here would hit higher earners in public sector defined benefit schemes – remember the issue with NHS doctors retiring early? And how much in tax relief would the Government save by such a change?
It’s the same groups who’d be most affected by reintroducing some form of lifetime allowance. As above, convention would be to offer protections to those already over the new limit, but this would reduce any short-term gain in tax collected. Is this really worth the time and effort involved?
Reform of tax relief on contributions
Something which would generate a larger and more immediate saving in tax relief would be moving to flat rate relief on personal contributions, particularly if this were set at – or not much above – the basic rate. Something between the basic and higher rate could be positioned as a boost to basic rate taxpayers at the expense of those ‘broad shouldered’ higher and additional rate taxpayers.
But as previous Chancellors have discovered, this change is complex and poses particular challenges for defined benefit schemes, which currently receive almost half of all tax relief on contributions.
There’s also the risk that higher rate taxpayers, whose numbers are growing rapidly due to the freezing of income tax thresholds, might be discouraged from pension saving. In reality, higher rate taxpayers would still have much to gain, including from employer contributions. Remember, until a retiree’s income is above the higher rate threshold, their pension in payment is still taxed at the basic rate. Advisers would play a crucial role in highlighting these aspects.
To avoid a mass movement towards salary sacrifice, flat rate relief on personal contributions would lead to employer contributions being treated as a benefit in kind, with some form of tax charge. In defined benefit schemes, employer contributions aren’t allocated to individuals so a ‘deemed’ employer contribution, based on generosity of benefits might be needed.
To put it mildly, these changes are far from straightforward and could not be implemented without significant preparation.
Pensions ISAs
The most radical change of all would be to scrap all upfront tax relief on pensions and allow the proceeds to be taken tax-free, much like ISAs. I’d see this as a disastrous move. The current Government is saying pensions should generate an income for life. But without taxing proceeds as income upon withdrawal, there would be little deterrent against taking the whole lot as a lump sum. To reflect a complete change in tax reliefs, every pension arrangement or scheme would need ‘paid up’ and a new one set up to allow for the difference in tax treatment on contributions going forward. And how would savers feel leaving the tax-free status of proceeds to the whims of future Chancellors in varying degrees of fiscal desperation?
Conclusion
No-one, and at the time of writing I believe that includes the Chancellor, knows what will actually be included in the Budget. Pension related, ISAs, income tax, National Insurance, other ‘wealth’ taxes or even the odd penny on ‘cigarettes and alcohol’. With so much speculation and so many possibilities, the only thing I’d feel comfortable predicting is that not all of these pension suggestions will happen. Indeed, there’s a good chance none of them will. What is clear is that currently, pensions are the best means of saving for retirement. And for the sake of the nation’s futures, as well as the UK’s growth prospects, it would be a brave Chancellor who did anything to change that.
Steven Cameron, Pensions Director, Aegon UK
Check out all the thinking and insights from experts across the industry who’ve been sharing their Budget outlook with us for today’s Friday Focus here: https://ifamagazine.com/category/friday-focus/
