Pension tax – what to expect from the new government
It seems likely that the new government will target pension savings in its first Budget. The media is rife with speculation and scaremongering. But what’s really likely to change and how might it affect you?
What are the likely changes?
There have been a number of hints that the Chancellor will announce higher taxes on pension savings in her 30 October Budget. The main targets appear to be: legacy funds in money purchase (MP) schemes (where you or someone else, e.g. your employer, pay into a fund which you can draw from age 55) which haven’t been undrawn when you die; reintroduction of the lifetime allowance (LTA) which caps the amount of funds qualifying for tax relief; and she might also look at reducing tax relief on pension contributions. We’re confident, despite suggestions to the contrary, that she won’t increase the tax rate on pension income.
Pension contribution relief
If you pay into an MP scheme for yourself, you’re entitled to tax relief on the contributions according to the rate of income tax you pay. If you pay higher rate tax (40%) on some of your income, you’re entitled to tax relief equal to 40% of the contributions you pay.
Example.Jack pays £15,000 into his pension in 2024/25. His income for the year is £60,000, of which £50,270 (the standard amount) is either not taxable or is taxable at the basic rate (20%). The balance of £9,730 is taxable at 40%. Jack is entitled to 40% relief on the £9,730 and 20% on £5,270. The net cost of the contribution to Jack is therefore £10,054 ((£9,730 – 40%) + £5,270 – 20%).
Possible change.The suggestion is that the government might change the rate of tax relief to a flat rate of 30%. This would be especially good news for lower earners who don’t pay higher or additional rate tax as they would get extra tax relief, but generally bad news for those who do. Those who only pay higher rate tax on a small amount of their income might still be better off with a 30% flat rate of tax relief.
Tip.Get more tax relief while you can. If you pay higher or additional rate tax on a significant part of your income, consider making a one-off pension contribution before the next tax year, perhaps even before the next Budget.
Reintroduction of the LTA
We think a return of the LTA is unlikely. The list of reasons for this are lengthy and the rules involved tricky. In our view, it wouldn’t bring in a significant enough tax haul for the complications involved.
IHT on legacy funds
The basic principle of a change to inheritance tax (IHT) on legacy funds would be to make any money left in an individual’s MP pension fund when they die liable to IHT. Currently, virtually all such sums are outside a person’s estate and so are not subject to IHT. Changing this might sound like an easy target for the Chancellor, but the tax haul is not as large as you might imagine. Estimates range between £2bn and £4bn over the next few years. One reason for the relatively low tax haul is that currently legacy funds are usually liable to income tax at up to 45% when paid to the deceased’s beneficiaries. This tax would have to be scrapped to prevent double taxation. Also, complex trust laws would have to be overcome. Lastly, the change would also be a disincentive for people to save into pensions, which no government wants. Therefore, we don’t expect anything more than the launch of a consultation in the next Budget.
Higher and additional rate taxpayers could face a reduction in the rate of tax relief they receive on their contributions into money purchase pension schemes. Consider maximising the higher rates of tax relief while you can by making extra contributions before the 2025/26 tax year.