Much is up in the air across many facets of pensions and tax policy, and until last week the main political parties had most of the rest of the year to make clear some intentions, says Gary Smith, partner in financial planning at wealth management firm Evelyn Partners.
However, campaigning is now well underway with limited clarity as the country looks towards a 4 July poll.
We haven’t seen the manifestos yet, and even when we do they might not contain much concrete detail on pensions, inheritance tax or the taxation of investments. So we are left in a world of probabilities, possibilities and suspicions around upcoming changes to the financial landscape that savers might have to navigate.
The fact that we are looking at a very probable change of government come 5 July throws up some urgent questions around what’s in store for pensions both state and private, or for families planning how pass on their wealth – but campaign rhetoric doesn’t provide many answers. We do know that change for savers is closer at hand than it was a fortnight ago.
We’ve had the surprise “triple-lock plus” gambit from Rishi Sunak, and while he might not get the chance to put it into practice, it does reignite the state pension debate, as well as disquiet over frozen allowances for everyone. Unless Labour moves to match it, which seems unlikely, it opens up some clear water on policy.
One elephant in the room is the prospect that a new Government might look to the taxation of pensions, or other wealth assets, to escape the fiscal restraints the main parties have imposed on themselves.
The Institute for Fiscal Studies and the International Monetary Fund have warned that both parties’ public finance projections indicate a significant funding gap, of up to £30billion, unless unscheduled spending cuts are enforced. A recent poll revealed that 56 per cent of British voters expect taxes to go up after the UK general election if Labour win, and 52 per cent if the Tories remain in power.[1]
Labour has now promised not to hike VAT, which means both parties have pledged not to raise any of the three biggest levies – income tax and national insurance being the other two – that account for the lion’s share of Treasury revenues. Labour has also vowed not to raise the headline rate of corporation tax, the fourth biggest fundraiser.
A new government might look at the tax treatment of pensions or certain IHT reliefs to bridge a funding gap that seems bound to open up even if public sector spending is severely restricted. Savers, however, should be very wary of acting on such possibilities and it is highly unlikely any changes to the tax system would be enacted before April 2025.
State pension triple lock (plus?)
The affordability of the triple-locked state pension is a can that keeps getting kicked down the road and an election is not the time that either main party is likely to break that pattern.
In fact, the Conservatives have doubled down with their £2.4billion “triple lock plus” pledge. Mr Sunak has said he would create an “age-related” tax-free personal allowance in the income tax system, which would rise to keep it above the rate of the state pension. This would mean two different personal allowances: one for working-age people that will be frozen until 2028 and another higher one for retirees that would change annually.
There are issues with this, apart from affordability and the potential to be generationally divisive. It’s not clear what sort of personal allowance would apply to those who continued to work after state pension age – and 1.37million people aged 65 and over were still in work last year. It would also add another level of complexity to the UK tax system.
It’s questionable whether the Conservatives would have tabled this policy if they had a good chance of remaining in power, but it does at least shine a light on how frozen thresholds are raising the tax burden by stealth. Promises from both parties not to raise headline tax rates offer little comfort when we all know we’re going to be paying more tax anyway due to fiscal drag.
One favour today’s workers can do for themselves is to assume the triple lock might not be sustainable for more than a decade, and that they need to save more than they think to make up for that.
The pensions lifetime allowance
Smith says, ‘While Jeremy Hunt’s abolition of the pensions lifetime allowance was widely welcomed, some of the details in the implementation have caused lingering uncertainty and confusion – as has Labour’s undertaking to reinstate it.
We hope Labour will soon offer some more clarity on how and when it plans to reintroduce the LTA. If an LTA is reintroduced, the key questions will be at what level, and will there be some sort of carve-out for highly-paid NHS clinicians? It seems very unlikely a new LTA would be set back at its most recent £1.073 million – a level that landed doctors and surgeons with unwelcome tax charges, exacerbated staffing shortages in the NHS and led to Hunt’s decision to abolish the threshold.
Under the last Labour government, the LTA ended up at £1.8 million, which would now be worth over £2.5 million adjusted for inflation since. It wouldn’t be surprising if the LTA was reintroduced at something like the £2 million mark.
Either away, it is important to understand that the LTA has been removed from the statute book and so a future Government wishing to reintroduce it could not just switch it back on the day after the election but would have to pass new legislation which would likely take the form of a Finance Bill on the back of a Budget – and Shadow Chancellor Rachel Reeves has ruled out a summer Budget.
The legislative process takes time and therefore is unlikely that a new LTA could be in place until April 2025. Applying a new LTA retrospectively would be highly contentious, open to challenge, and therefore unlikely. There is also strong precedent, from the original introduction of the LTA and previous reductions in the threshold, that those impacted would able to take out protection, typically by ceasing further funding.
Given all this, for some savers who may have previously ceased pension funding because of the LTA and are very keen to restart with regular or lump sum contributions, the current window of opportunity might be worth taking advantage of, after taking some advice.
But making drastic changes to one’s financial plans in what is a fluid situation is probably inadvisable, particularly for those who are about to access their pots. For instance, if some savers are thinking of rushing to access their 25 per cent tax-free lump sum because of fears over what Labour might do – as some reports have suggested – they should take advice before any hasty action.
Could there be other changes to pension taxation?
The Conservatives have affirmed that they would not introduce any new taxes on pensions or increase existing ones for the whole of the next Parliament. They would maintain the 25 per cent tax-free lump sum and tax relief on pension contributions at the marginal rate of income tax. National Insurance would not be extended to employer pension contributions.
We have no indication of any such plans from Labour but no such assurances either. In spite or because of this, the taxation of pensions is inevitably drawing some speculation, not just over the reintroduction of the LTA, but other areas where a future government could look to raise revenue.
Labour objected to Jeremy Hunt’s pension taxation reforms at the 2023 Budget as “a tax gift to the wealthy”, so the increase of the annual allowance from £40,000 to £60,000 cannot be considered untouchable. The annual allowance is arguably an easier and more efficient way to cap the amount spent on pension tax relief than the LTA, so some sort of reversal of the AA increase is not unthinkable, whether it comes alongside or instead of a new LTA.
Another way to limit the Treasury spend on pension tax benefits would be to reduce or do away with the 25 per cent pension commencement lump sum, or to limit tax relief on pension contributions. Either measure would be controversial, and the latter would be an administrative challenge, so they are perhaps unlikely, at least early on in a new government’s parliament.
But as pension contributions are an effective way to pay less tax as thresholds remain frozen, it’s understandable if suspicions that a new government might look to cap or reduce tax relief in some way are leading some savers to stash cash into their pensions now.
One final tax-preferential treatment of pensions that could come under scrutiny is the exemption of defined contribution pension pots from inheritance tax.
The questions around inheritance tax exemptions
Labour have made it clear they think some inheritance tax exemptions and allowances are too generous, so it’s possible some sort of measures will be taken to reduce them if they gain power.
While the IHT-exempt status of defined contribution (or money purchase) pension pots has not been mentioned by Labour, it has been highlighted more than once by think-tanks as an anomaly, so it might well be on Rachel Reeves’ radar.
If some steps were taken to levy IHT on the transfer of pension assets, this would probably lead to a widespread draining of drawdown pots, and a lurch towards other assets and tactics that mitigate against IHT, which at 40% is quite significant.
The other major talking point on IHT is around business and agricultural property reliefs, with a think-tank this week highlighting how they help some large estates shelter assets from IHT, and questioning the potential eligibility of most AIM shares for Business Relief.
There are legitimate reasons behind business and agricultural IHT reliefs, which help family and rural business to remain intact and going concerns on the death of owner, thereby savings jobs and assets of community value. Objections to the inclusion of AIM shares miss this point, and even a drive to remove AIM shares from Business Relief must take into account that it’s there to encourage private investment in small British firms that is sadly in short supply in the UK economy at the moment.
By Gary Smith, partner in Financial Planning at wealth management firm Evelyn Partners
