Pension tax changes are predicted to be a part of the forthcoming budget next month. We go through each of the potential changes to pension taxes and the likelihood of them being implemented.
The main areas of pension taxes that are hinted to change are as follows:
– Reduction in tax relief on pension contributions
– Increasing the tax rate payable on pension income
– Reintroducing the lifetime allowance (LTA)
– Inheritance tax payable on legacy funds
Current system – You receive tax relief on pension contributions according to your income tax rate (e.g 40% for higher-rate taxpayers)
Potential change – A flat tax relief rate of 30% might be introduced. This could benefit lower earners while reducing benefits for higher-rate taxpayers.
Likelihood – Politically this could go down well with the new labour government as it helps lower earners and penalises higher earners, so we give this an average chance.
Tip: Higher and additional rate taxpayers should consider increasing their contributions before any changes take effect, potentially even before the next Budget.
Current system – Can typically take up to 25% from your pension pot tax free. The remaining 75% is taxed at income tax rates.
Potential change – reduce or abolish the 25% tax free pension amount or increase the rate of tax chargeable.
Likelihood – We don’t think that this is likely as it would reduce the incentive to save into a pension scheme.
Current system – The lifetime allowance (LTA) was abolished in April 2024. Prior to this there was a limit an individual could save in pension schemes without incurring a tax charge.
Potential change – Reintroduce the LTA.
Likelihood – A return of the LTA is considered unlikely due to complexity and the limited tax revenues it would provide.
Current system – Pension funds are generally not subject to inheritance tax (IHT) when undrawn funds are passed on.
Potential change – Any change could make these pension funds liable to IHT.
Likelihood – This is not expected due to potential complications and disincentives for individuals saving into a pension.
Conclusion on the Potential Pension Tax Changes:
No Government wants to disincentivise people from saving into pensions. For that reason alone it is difficult to see any major pension tax changes being included in the October 2024 budget. We predict that most of the media speculation will fail to materialise.
The only aspect we believe might gain some support is the 30% flat rate tax relief on pension contributions. Our reasoning is that, while it may discourage higher rate taxpayers, it serves as an incentive for lower rate taxpayers. Therefore, it could be seen as having a neutral impact overall.
For higher and additional rate taxpayers, it may be advantageous to make additional pension contributions before any legislative changes occur in order to maximise current pension tax reliefs.
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