Budget preview: what to expect on pensions tax relief, tax-free cash and the triple lock

Rachel Reeves’ first Budget as Chancellor (to be held on 30 October) has been preceded by feverish speculation over whether pensions could be in the firing line as the new government scrabbles to raise cash to strengthen public finances.

However, having already drawn the ire of retirees by means-testing the Winter Fuel Payment, the Chancellor will likely be cautious about targeting older people for the second time in the space of a year.

Recent reports suggest Reeves has backed away from the idea of fundamentally reforming pensions tax relief by introducing a ‘flat rate’ of tax relief set somewhere between 20% and 30%. This idea always felt like a non-starter, primarily because implementing such a reform would effectively result in millions of ‘working people’ – exactly who the Chancellor and Prime Minister have said they will protect – being hit with tax hikes.

Having just settled pay disputes with NHS workers, it is hard to imagine the new government will be spoiling for another fight over public sector pensions.

The other suggested target on 30 October is pension tax-free cash, with some suggesting the maximum someone can take in their lifetime – currently set at £268,275 – should be lowered. Any move along these lines would be deeply unpopular and potentially hugely complicated too. What’s more, neither reforms to pension tax relief nor paring back tax-free cash entitlements would likely deliver the substantial in-year savings sought by the Treasury.

The level of uncertainty created ahead of the Budget has real-world consequences, with both contributions and the number of people taking their tax-free cash rising in recent months.

It is not desirable that some savers feel forced to take decisions based on rumour and speculation rather than their long-term retirement goals.

Given one of the key promises made by the new government was to deliver economic stability to Brits, Reeves should use her Budget to nip this issue in the bud by pledging not to make major changes to either pension tax relief or tax-free cash.

This ‘Pensions Tax Lock’ would send a clear signal to savers that the goalposts won’t be moved and should give people more confidence to take decisions based on their long-term interests.

A new pensions ‘death tax’?

The tax treatment of pensions on death will be viewed by many as low hanging tax fruit ready to be picked.

"Under existing rules, it is possible to pass on your retirement pot completely tax-free to your nominated beneficiaries if you die before age 75 and your pension provider distributes benefits within 2 years. If you die after age 75, any inherited pension is taxed in the same way as income. Crucially, pensions usually don’t form part of people’s estate for inheritance tax (IHT) purposes.

This is a generous set of rules and something which could easily be reviewed by the new government. However, as is often the case with pensions, applying any new tax on death – or bringing pensions into the IHT net – would come with substantial challenges.

The biggest of those challenges would be around how to treat people who have made decisions about their retirement pot based on the pensions death tax rules as they are today.

There will, for example, be lots of people who chose to transfer defined benefit pensions into a defined contribution scheme in part because they wanted to prioritise passing money on tax efficiently to loved ones. If all of a sudden that money became subject to a new pension death tax, those people would feel like the rug has been pulled from under them.

It is possible a complicated protection regime would be needed to ensure people are not subject to unfair and arguably retrospective tax measures. This would inevitably reduce the money the Treasury could potentially raise from such a move.

Ending National Insurance (NI) relief on employer contributions?

There are no easy choices for Reeves, but National Insurance relief on employer pension contributions could be an appealing target for a chancellor with limited options.

This relief currently costs around £17 billion a year, according to the Institute for Fiscal Studies, and charging NI, even at a lower rate than the standard 13.8% employers pay, would raise significant sums without breaking any of Labour’s key election pledges.

Politically, this would also be less risky as it wouldn’t hit voters directly in the pocket – although there is a danger employers will scale back remuneration, including pensions, to meet this extra cost.

If the government goes down this road, it will face a difficult balancing act deciding the level of tax that raises sufficient revenue without undermining its central objective of boosting economic growth.

State pension ‘triple-lock’

While next April’s increase in the state pension is pretty much bolted on, it would hardly be surprising to hear Reeves use the Budget statement to re-announce Labour’s commitment to the ‘triple-lock’. UK pensioners are on track to see a sizeable inflation-beating increase to their state pension next year of almost £500, to just under £12,000.

The government’s commitment to the triple-lock pledge means it’s likely the earnings growth figure of 4% will be used to determine the rise in the state pension next year. And at a time when inflation has fallen back closer to the Bank of England’s targeted rate of 2%, this will give a welcome boost to pensioners’ income in real terms.

Sticking with its triple-lock promise may help redeem the government in the eyes of UK pensioners. The government is coming under more intensive pressure to ‘U-turn’ on its controversial decision to axe the Winter Fuel Payment for all pensioners, except those who claim Pension Credit. Although the increase to the state pension should help meet next year’s bills, it doesn’t help those who will be living close to the edge of their means this winter.

The triple-lock guarantee has worked well in the favour of pensioners over the recent past, boosting the state pension by 28% over the last four years. But with the state pension edging ever closer to the frozen personal allowance of £12,570, and the concept of universal payment coming under increasing scrutiny, the government will have to take the bull by the horns at some point to address who should get the state pension, at what age, and how much.