What pension changes can we expect from the budget?

Steve Herbert examines the options and factors that could influence any future changes to pensions.

Former Liberal Democrat MP, Sir Steve Webb, claimed last week that placing National Insurance Charges on employee pension contributions would raise billions of dollars for the country’s coffers.

Webb, a partner at LCP where Webb has been a consultant for many years, conducted an analysis that estimated the cost to the government of tax relief on pensions in 2022/23.

In recent weeks, I’ve been asked in business and personal conversations whether there will be any changes in the tax relief for pensions.

Only the chancellor Rachel Reeves, and her team at the Treasury, know for sure what decisions will be made by the end of this month. However, it is possible to make some good guesses about what these decisions might be.

We need to take into account all competing factors, not just those relating to pensions and the industry.

What you should consider

First, we must accept that the country’s finances are in a bad state. Therefore, raising revenue and cutting state expenditures is a non-negotiable for this Budget statement.

The chancellor must now find other “big ticket” wins to balance his books, as many of the potential sources of tax revenue are no longer in scope due to the manifesto promise not to increase taxes.

Second, we must recognize that tax benefits inherent in pension saving are enormous. They amount to around PS50bn per year.

Pensions can be attractive to savers and still offer a tax-efficient alternative.

The government and the Prime Minister have stated their intention that the wealthier people will bear the most financial burden from any taxation change.

The widespread backlash from the media and the electorate in relation to the decision on winter fuel payments is likely to put this at the forefront of political thought.

Manage changes

The government is likely to consider whether changes to the pension tax relief will be easy to implement and administer.

It will be more difficult to implement complex changes, which could lead to the development of strategies for tax avoidance to reduce the impact on the savers.

Any change must pass the “smell” test from a political perspective. Changes must be seen as fair and proportionate.

Any changes announced cannot be so harsh that people stop saving, because that would ultimately lead to an increased reliance on the state for retirement support.

We must not forget that improving economic growth is the only way to get out of the apparent financial mess in the UK.

Businesses may struggle to grow as fast as they need to if they are faced with significant and new pension costs.

What are the options available?

There are only three “big ticket” pension items that the chancellor should consider.

Option 1 – Remove the tax-free cash amount at retirement

It sounds simple, and it is (but only if everyone gets the same benefit), but the reaction from those who have made savings with the 25% tax-free element in mind will be massive.

It would be a compromise to protect cash amounts already accrued. This is a complex and clunky solution that will reduce the short-term gains needed by the government.

Option 2 – Apply National Insurance (NI), to employer pension contributions

This option has been a hot topic at the moment, and HM Treasury must find it attractive given that it would mean a 13.8% rise in National Insurance payments for all employer pension contributions.

This change would be difficult to understand by most savers, and the costs would fall more on businesses than on scheme members. The government would not suffer a major loss of votes as a result.

This measure would increase employment costs significantly in an economy that is still stagnant. This option would be a major drag on the UK’s economic growth.

The Treasury may still be interested in this method, despite the fact that it is less popular than the salary sacrifice payment route.

The sting is that employers use the savings in NI associated with salary sacrifice to pay pension contributions.

Many employers would have to rethink the level of support they provide their employees if this saving was removed.

It would be bad in any case, but the NHS is currently “broken”, according to the government. Therefore, it’s essential that companies continue to fund medical insurance as well as other forms of support.

The mission to boost the economy is a success if Britain’s workforce remains healthy, fit and productive.

Option 3 – Level tax relief for employee contributions

The old chestnut about taxing pension contributions at the same rate is not to be forgotten.

The highest earners should require less financial assistance to save for retirement. However, tax relief at the maximum marginal rate on pension contributions favors these high earners.

There is no reason to reduce tax relief to the basic rate for everyone.

This option is easy to understand and communicate, as well as financially lucrative for Treasury. It offers the Labour Government the political advantage of targeting the high-income groups over those with more moderate incomes.

It would also reduce the likelihood of damaging headlines or voter backlash.

Keeping the basic rate reduction in place will ensure that retirement savings remains an attractive option to all.

Difficult decisions

There are many differences between the Defined Benefit and the Defined Contribution options, the public and private pensions, the decumulation options, and the taxation of rich and poor.

Option 3 offers the Treasury a significant financial benefit without affecting the economy or growth. It is the quickest and cleanest option.

In such decisions, the logic often takes a back seat to the pressures of lobby groups and bean counters. Other options, including the tax treatment for pension funds at death, may be considered.

Only time will tell. I’ll be watching with greater interest than usual this statement.

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