Budget 2024 pensions predictions

Chancellor Rachel Reeves will deliver her first Budget on 30 October 2024, against a backdrop of a £22billion deficit and a manifesto pledge not to raise income tax rates, NIC or VAT “for working people”. 

The sentiment is that the Chancellor may look to the UK pensions tax system to plug some of this gap and there has been speculation as to exactly what measure or measures the Chancellor may seek to introduce. In this article, we explore the key aspects of the UK pensions tax system potentially ‘at risk’ of intervention. 

1. Introducing a flat rate of income tax relief on pension contributions

Under this measure, contributions into a UK tax approved pension scheme would benefit from a flat rate of income tax relief only, with 30% relief being widely mooted, rather than relief at the applicable income tax rate of the individual pension saver.  

Two issues this proposed measure gives rise to are:

i. A flat rate of income tax relief runs the risk that pension savers would benefit from a rate of relief that is lower than the rate of income tax that they will eventually pay on their pension income, depending on the level of other income in retirement.  The risk of this situation arising could make paying into a pension significantly less attractive for those impacted.  

ii. From an administrative standpoint, changing tax relief ‘on the way in’ is inherently problematic and difficult to do in a coherent way, particularly for defined benefit pension schemes which, according to the Institute of Fiscal Studies, 46% of income tax relief is attributable to. That being said, with income tax relief - after taking into account tax charges that can apply on funding - estimated at £42.2bn for 2022/23 alone, it is not difficult to see why reducing relief on the way in would be one way for the Chancellor to address her deficit challenge. .  

2. Applying income tax to lump sum death benefits paid under 75 years

Under the current UK tax regime, lump sum death benefits paid out from a UK pension scheme do not attract income tax if the deceased was under the age of 75 years and the amount does not exceed the “Lump Sum and Death Benefit Allowance” (normally £1,073,100).  This is in contrast to where a death event occurs when a pension saver is aged 75 or over, in which circumstances the lump sum death benefit is subject to a UK income tax charge on the recipient of the death benefit at their marginal income tax rate. 

There is no clear rationale as to why death benefits under £1,073,100 should be paid free of any income tax if a pension saver is under the age of 75, but fully taxable if they die on their 75th birthday.  Arguably this creates taxpayer unfairness, hence a measure to correct this disparity would not be surprising. 

3. Introducing inheritance tax on death benefits  

The Government has, on several occasions, indicated its view that pensions should be subject to inheritance tax, where currently pension benefits do not, as a general rule, fall within a pension savers estate on death.  Charging both income tax and inheritance tax on death would give rise to some significant tax charges – for example, a beneficiary who is an additional rate taxpayer would have a 67% effective tax rate on the benefits, assuming they are only taxed on the net amount after inheritance tax.  

Furthermore, the potential for a double charge could create an incentive to pension savers to take money out of their pensions too early and give it away (and thus availing themselves of existing inheritance tax exemptions) potentially leaving them with too little to live on when they need it.

4. The removal or reduction of the 25% tax free cash amount

HM Treasury has estimated that the 25% tax free cash benefit of a UK pension costs £5.5bn per annum. The Institute of Fiscal Studies and political think tanks have mooted a £100,000 limit on the total amount of tax free cash that pension savers should be able to access on retirement. This is on the basis that capping it at this level instead of the current £268,275 would raise the not insignificant sum of approximately £2bn, but would only affect a fifth of pension savers, on the basis that most people’s pots are well below £400K.  

Furthermore, given the recent changes to pensions tax rules following the abolition of lifetime allowance, the tax free amount is now written in law as a number, which theoretically would be straightforward to amend.  What will be more complex of course is how His Majesty’s Revenue & Customs will seek to grandfather rights to a higher level of tax free cash for pension savers who have contributed into their pension scheme with an expectation of receiving 25% tax free on retirement, if indeed grandfathering is something the Government would want to consider.  

5. Removing employer National Insurance Contributions relief on pension contributions

Employer NIC relief on contributions into UK pensions cost approximately £15.4bn in the 2022/23 tax year according to recent statistics (the IFS estimates this cost rising to approximately £17bn per annum).  Given this, it is not surprising that a change to employer NIC relief on pension contributions is being widely mooted as likely to change.

Given the risks to ongoing pension saving, the Government is unlikely to introduce a blanket 13.8% on all employer pension contributions.  Rather, the IFS considers that any employer NIC levy may be combined with a subsidy on employer contributions –which if introduced in tandem would still have the capacity to generate significant revenues (approximately £4.5bn), thus making a meaningful dent in the fiscal deficit.  

Re-introduction of the Lifetime Allowance (LTA)

Finally, there has been some discussion as to whether the Government will seek to reintroduce the LTA (something which, prior to the General Election, it had indicated it would do when its abolition was first proposed). We reference this only for completeness as, in reality, the reintroduction of the LTA is generally thought to be highly unlikely -  it does not raise significant revenues (current estimates suggest that the LTA regime raised approx. £500m only) and it is important to remember that the 55% charge under the old LTA regime has been replaced by other tax charges (for example, income tax of up to 45% - or 48% if you live in Scotland - on lump sum benefits above the new Lump Sum and Death Benefit Allowance).  

A return to the old LTA regime would also be extremely administratively complex to achieve and place a significant burden on pension scheme administrators who have only just updated their systems, processes and policyholder communications to deal with the abolition of the LTA.  

The UK pensions tax system, as currently structured, does provide generous levels of tax breaks for those with bigger pension contributions, higher earners and those benefitting from larger employer pension contributions and, as such, it is not surprising that the Government has pensions tax reform in its sights.  That being said, it is critical that we do not ignore the need to offer tax breaks to incentivise pension savers to continue to save for their own retirement, recognising that greater reliance on the state system is untenable.  As such, there is a need for careful, considered and well consulted reform over time, rather than knee-jerk, short term revenue raising measures which could have more serious repercussions for long term / retirement saving in the future.