Labour Pension Reform: What Could Change in the Upcoming Budget?

As the UK faces an apparent £22 billion deficit in public finances, the newly elected Labour government is preparing to announce a series of significant changes in the upcoming budget.

With the nation's economic health under intense scrutiny, the government has indicated that those with the “broadest shoulders” will be expected to bear a heavier burden in addressing the financial shortfall. Speculation is rife about the specific measures Chancellor Rachel Reeves will introduce, with many wondering how the changes will affect the wider economic landscape, particularly the pension system, and future financial planning.

The Labour manifesto has made it clear that a review of the current pensions and retirement savings framework is imminent. This is a system that currently enjoys a variety of tax advantages, including tax relief on contributions, tax-free growth, and exemptions from inheritance tax (IHT). These incentives are designed to encourage long-term saving for retirement, a key consideration for individuals planning their financial futures. However, any alterations to these benefits will require careful calibration to avoid discouraging savings and inadvertently increasing pressure on public resources in the future.

The question now is: What changes will Rachel Reeves propose, and will they strike the right balance between boosting government revenues and maintaining incentives for long-term financial planning?

Pension Tax Relief

Pension contributions benefit from tax relief, which means that the government pays back any income tax that would have been paid on the contribution. This is essentially the government's way of incentivising people to save for their retirement. For example, for basic rate payers, a contribution of £80 becomes £100 inside a pension. Higher and additional rate taxpayers benefit the most.

One proposed reform is the introduction of a flat rate for pension tax relief. However, given the complexities involved in implementing such a change, it's unlikely to be introduced in the near future, meaning it wouldn't provide immediate financial benefits for the government.

Annual Allowance Reduction

One straightforward change would be to reduce the annual allowance, which was increased to £60,000 last year. The annual allowance had been increased to encourage higher-paid public sector workers to remain in the workforce. Therefore, reversing this increase could discourage public sector workers from continuing to work and thereby indirectly dilute any benefit to be obtained from this measure.

Reinstating the Lifetime Allowance

This is something the Labour Party initially said they would do, but subsequently dropped their plans as it would “add uncertainty and be too complex to introduce.”*

Pensions and Inheritance Tax

Money held in a pension is outside a person’s estate for inheritance tax purposes. In 2015, the Conservative government introduced pensions freedom, allowing people to pass on their pensions without inheritance tax applying. For death pre-75, the money can be passed on free of tax, and for death post-75, the beneficiary would be taxed at their marginal rate of income tax.

Including pensions within the estate for inheritance tax purposes is another option the government may be considering. However, any changes to the current system would not provide immediate financial gain to the government and may lead to pensioners taking money out of their pensions and sheltering these funds elsewhere.

Tax-Free Cash

Currently, 25% of pension money can be accessed tax-free in the UK, up to a limit of £268,275. Several clients have been concerned whether this option will remain available in the future.

The Institute for Fiscal Studies has suggested reducing the tax-free cash to £100,000 and believes this would raise around £2bn a year in the long term. *However, they also acknowledge that this would be a retrospective taxation on savers, who have likely built this into their retirement plans.

Despite these suggestions, the Labour Party confirmed during their election campaign that they wouldn’t roll back this benefit after all:

"The ability to withdraw 25 per cent of your pension as a tax-free lump sum is a permanent feature of the tax system and Labour are not planning to change this."***

What Can You Do to Plan Ahead of the Autumn Budget?

Firstly, avoid making any major changes based on speculation, as no one knows for sure what the outcome will be.

If you are planning to pay extra into your pension this year, consider doing so before October 30th. Additionally, make use of any unused allowances from the previous three years. For clients overseas, it is still possible to continue paying into an existing UK pension after leaving the UK. An individual can pay 100% of their earnings in the tax year they left the UK and £3,600 for each of the subsequent five years.

If you were considering taking action soon, it may be wise to do so before the Budget is announced. For instance, if you have a major capital expenditure or a planned gift in the foreseeable future, you're currently operating under existing rules, which may change with the Budget and affect your original intentions.

While potential tax changes shouldn't derail your financial plans, it's important to stay flexible and adaptable to ensure that any new measures don't hinder your ability to achieve your financial goals.

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