Rumours are flying around over changes that might get announced in the forthcoming Budget, with many predicting a big day for pensions.
In the first Labour Budget for more than 14 years, chancellor Rachel Reeves has warned of ‘hard decisions,’ to be made in trying and fill a £22bn ‘fiscal black hole’ – leaving many savers feeling worried.
Here we look at potential announcements – and what they might mean for you.
Removal of NI relief on pension contributions
Under current rules, if money is paid into a pension, employers do not need to pay National Insurance (NI), and nor do employees. But under a change being touted as one of the most likely to get announced, we could see employers having to pay NI on contributions.
Pension experts say this would be a ‘relatively simple change’ for the Government and could raise large sums. Initially this could be charged at around 2%, raising around £2bn. But there are concerns about this move. Becky O’Connor from PensionBee, said: “While altering the way NI is levied on contributions may raise revenue, it could have the negative consequence of making employers less generous in their pension offers to employees.”
Alice Haine of Bestinvest agrees that such a move could have unintended consequences: “It would place an additional burden on businesses, who might choose to reduce headcount or stick to the auto-enrolment minimum rather than extend it to cut costs.”
A cap on tax-free lump sum
We’ve seen a lot of headlines relating to potential plans to cut the tax-free pension lump sum to just £100,000 – a third of the current limit. At present, at retirement, savers can take 25% of their pension pot – up to £268,275 – without paying income tax. However, the Government has been speaking to groups including the Institute for Fiscal Studies (IFS) and the Fabian Society, which argue that the lump sum should be capped because the current level favours the wealthy.
This change, it is suggested, could affect one in five retirees. Such rumours have prompted some savers to contemplate withdrawing their tax-free cash now in a bid to ‘get ahead’ of possible changes. But this could have big ramifications.
O’Connor said: “The 25% tax-free lump sum is widely recognised as one of the most popular pension benefits. The £100,000 cap would be a low threshold and would mean anyone with a total pension of £400,000 or more would be impacted. So, a cut of this magnitude would negatively affect millions of middle-income retirees.”
It would also cause those on the cusp of retirement significant difficulty with decision-making.
Michael Summersgill from AJ Bell, added: “Rumours about the future of tax-free cash, one of the best understood and most valued benefits of pensions, are particularly problematic. Taking your tax-free cash is an irreversible decision.”
Equally, if the Chancellor doesn’t end up doing this, those who have withdrawn money may find they’re in a worse financial position long-term. Make sure you think carefully before rushing to take tax-free cash from your pensions.
Changes to passing on pension pots without IHT
Under current rules, defined contribution pension pots are usually not counted as part of a deceased’s estate for inheritance tax purposes. This means that large sums can be passed on free of IHT. And, if the pension holder dies before 75, beneficiaries can receive withdrawals from pots income-tax free.
But all this could change if these laws get amended, as pension pots would then be included in the value of estates at death for IHT purposes. O’Connor said: “This would remove a key advantage that pensions have over other forms of long-term investment for those focused on tax efficiency.”
Implementation could also be a long and costly process. Ian Dyall, head of estate planning at Evelyn Partners, said: “It’s quite possible the Budget will reform the favourable tax treatment of pension pots at death, as it can be portrayed as fixing an IHT ‘loophole.’ The question is, if this does occur, will there be any transitional arrangements for those who have made significant financial decisions on the basis of current rules?”
Equally, while taking pots at death might not have a big impact on economic efficiency, there are likely to be behavioural implications, as savers seek other steps to mitigate IHT.
A limit on the tax relief available for pension savers
Further to the potential changes laid out above, there has also been talk of amendments to tax relief – with suggestions it could get cut to between 20% and 30% for those saving into a pension. At present, workers don’t pay any tax on earnings they put into their pot. This means that if you pay £80 into a personal pension, an additional £20 is automatically added as basic-rate (20%) tax relief. Higher-rate (40%) and additional rate (45%) taxpayers can then claim back an extra £20 or £25 through their self-assessment tax return.
A move to a flat rate of tax relief would be good news for basic-rate taxpayers, but would mean higher earners will need to pay some tax on their contributions. O’Connor said: “A flat rate could offer 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.”
But there are concerns higher earners may see less incentive for saving for retirement. Lily Megson, policy director at My Pension Expert, said: “Tax relief is a major incentive for retirement saving, and with under-saving already a significant issue, such a move would be bold – and potentially very risky.”
At the time of writing there were reports that the Chancellor was backing away from such a measure, though this hasn’t been officially confirmed.
Don’t jump the gun
What you need to do right now is take all this as what it currently is – speculation. With this in mind, you need to resist the temptation to act too quickly. Rob Burgeman from RBC Brewin Dolphin said: “Many people may be tempted to try and take action with their personal finances. But unless you have a crystal ball, you shouldn’t do anything too drastic. It can be a dangerous game to double guess what the chancellor might do.”
This is a view shared by Greg Hendricks from Wesleyan Financial Services. He said: “Rushing to take action now risks undoing years of careful retirement planning. It’s wisest to wait until we have more clarity.”
If you’re not sure what to do, you may want to seek guidance from a financial adviser. The key is to just ensure you are ready to act quickly should the rules change at any point.
Photo by Allef Vinicius on Unsplash
