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Will pension tax relief perks be plundered to pay the Covid bill?

A rumoured raid on pension tax breaks to help pay the massive bill for fighting Covid-19 has provoked an outcry in defence of savers.

Slashing the lifetime allowance from just under £1.1m to £800,000-£900,000, a big cut in pension top-ups for higher earners, and new taxes on employer contributions into retirement pots are reportedly being looked at by the Treasury. 

Pension experts have lined up to warn the Government against undermining the retirement plans of a swath of the public, or face a massive backlash – including from Tory voters.

Pension tax breaks: Will retirement savers be plundered to pay the Covid bill?

In the March Budget, Chancellor Rishi Sunak announced that the lifetime allowance, the total amount you can pay into a pension and still get tax relief, would be frozen at £1,073,100 until 2026.

The move, accompanied by similar freezes in capital gains annual allowance and inheritance tax thresholds, is so recent that talk of a far more drastic cut has prompted criticism of ‘chopping and changing’ and a suggestion the Treasury is ‘suffering from schizophrenia’.

The three possible reforms to pension tax rules are being considered due to pressure on public public finances after high spending to combat the coronavirus crisis, according to the Telegraph, citing well-placed Whitehall sources.

However, Boris Johnson’s government is so far standing behind its commitment to the triple lock on state pension increases, despite concerns that wage distortions could lead to a big rise in payments next Spring. 

What would the changes mean for savers?

A cut to the LTA would affect higher earners who are still saving for retirement, including those who saved hard early on and whose investments have done well, and those in final salary pension schemes like doctors and headteachers.

The LTA is not a limit on how much can be paid into a pension, as savers can continue paying in above it, but hefty tax charges will then hit them when they retire.

People are planning for a generation. What they can’t have is constant chopping and changing of the pension rules because the country is broke 

Steve Webb, former Pensions Minister 

Any money above this level taken as income incurs an extra 25 per cent charge and as a lump sum it incurs a 55 per cent charge – this comes on top of normal income tax.

Meanwhile, a shake-up of pension tax breaks that could see Government top-ups into retirement pots lowered to the 20 per cent basic rate for everyone – or set at 25-33 per cent if the Government is more generous – has been mooted for years. 

The latest report suggests the Treasury is currently looking at a flat rate of 30 per cent, which would boost contributions for lower earners.

But the move, which would hit people who get higher top-ups because they pay a 40 per cent rate of tax, was rejected by the Treasury in autumn 2018. 

It dismissed a call by MPs to look at overhauling the long-running principle of saving into a pension from untaxed earnings, saying there was ‘no consensus for either incremental or more radical reform’.

Any changes could have ‘significant impacts’ for pension schemes, employers and individuals, it added.

Practical problems include scuppering workplace salary sacrifice schemes, which reduce National Insurance for staff and employers, and the technical challenges of implementing the new system for final salary pensions. 

When it comes to employer contributions into pension pots, these are tax free at the moment, and new levies would be a blow to businesses recovering from the pandemic.

This could deter them from putting in more than auto enrolment minimum payments, leaving staff to make up the shortfall or eventually retire with smaller pots.

All three of the pension tax reforms apparently in the Chancellor’s sights would be hugely risky, hitting directly at heartland Conservative voters 

The proposals above are reportedly under consideration ahead of the Autumn Statement, which is expected in November.

Similar rumours of a pension overhaul in the past have led to a big rush of money going into pots, as people try to mitigate the risks to their savings by taking advantage of current rules.

That’s landed the Treasury with a temporary but large extra tax relief bill – even though the Government’s mooted money-raising reforms never actually materialised to offset this cost.

Today, a Treasury spokesperson said it does not comment on speculation about tax changes.

Meanwhile financial experts have issued scathing responses, which we round up below.

Paying the Covid-19 bill: Boris Johnson has signalled he wants to keep the commitment to the state pension triple lock, and Rishi Sunak's Treasury is reportedly pondering other money-raising ideas

Paying the Covid-19 bill: Boris Johnson has signalled he wants to keep the commitment to the state pension triple lock, and Rishi Sunak’s Treasury is reportedly pondering other money-raising ideas

What do pension experts say?

Former Pensions Minister, Steve Webb, now a partner at pension consultant LCP, told the Telegraph moves like these would be politically risky for the Conservative party.

‘If you want 200 more Chesham and Amershams, put together a package like this on pensions tax relief,’ he said. ‘It’s absolutely targeting your base. 

‘It is people who are working, earning a good wage and being frugal. Of all subjects, pensions should be a long-term business.

‘People are planning for a generation. What they can’t have is constant chopping and changing of the pension rules because the country is broke.’

Reducing the LTA once again runs the risk of severely impacting senior NHS staff and other public sector workers who may well just decide to retire 

Tom Selby, senior analyst at AJ Bell, says: ‘The Treasury appears to be rolling the pitch for another raid on people’s pensions, this time as part of an economic package to fund the UK’s coronavirus recovery effort.

‘Given the parlous state of the UK’s finances, further speculation about the future of all areas of Government spending – including retirement savings incentives – was inevitable.

‘However, all three of the pension tax reforms apparently in the Chancellor’s sights would be hugely risky, hitting directly at heartland Conservative voters and undermining the foundations being laid by automatic enrolment.

‘Introducing a flat-rate of pension tax relief, an idea often touted by think-tanks, would present genuine practical challenges and would likely result in tax rises for public sector workers in defined benefit schemes, including many of the NHS staff who have been rightly praised as heroes during the pandemic.

‘The lifetime allowance has already been cut to the bare bones, while employers would likely be furious if the Government increased their pension costs just as many attempt to recover from a nightmare year.

‘More fundamentally, while dealing with the pandemic is the biggest short-term crisis facing the UK, inadequate retirement saving remains one of the most significant long-term challenges.’ 

Kay Ingram, public policy director at LEBC, says: ‘The freezing of the LTA until 2026 will already reduce its value in real terms.

What are defined contribution and final salary pensions?

Defined contribution pensions take contributions from both employer and employee and invest them to provide a pot of money at retirement.

Unless you work in the public sector, they have now mostly replaced more generous gold-plated defined benefit – or final salary – pensions, which provide a guaranteed income after retirement until you die. 

Defined contribution pensions are stingier and savers bear the investment risk, rather than employers. 

‘If inflation levels out at the Bank of England target of 2 per cent per annum by 2026, the £1,073,100 allowance will only be worth £971,906 in real terms.

‘The impact of the LTA results in huge differences between what defined benefit (mostly public sector) and defined contribution (private sector) retirees can accrue with the benefit of tax relief.

‘A defined benefit member could receive just over £53,000 per annum pension and remain within the LTA, whereas, given current annuity rates, a defined contribution member could only expect to buy a lifetime income of £29,000 per annum on the same basis – less than the average wage.

‘If these rumours are true the Treasury appears to be suffering from schizophrenia in its pensions tax policy making and needs to adopt a more coherent approach.

‘Constant tinkering with pensions savings tax only undermines the incentive to save for the longer term.’

Ian Browne, pensions expert at Quilter, says: ‘The Government’s manifesto commitments have left them with little room to manoeuvre when it comes to putting the public finances back on track.

‘The promise not to raise income tax, national insurance or VAT gives them few levers to pull, and since they’ve already tried freezing various rates and reliefs at the last Budget, it’s no surprise that the next target is pensions.

‘There’s always going to be a tussle between number 10 and number 11 on spending decisions, and after the by-election defeat last week this is the ideal time for the Treasury to spring the rumour mill back into life.

‘The by-election loss provides Sunak with an argument to say that Johnson has to be more measured in his spending desires, or else the increased spending will have to be balanced by tax changes that will predominantly impact the Tory heartlands.

‘Reducing the LTA once again runs the risk of severely impacting senior NHS staff and other public sector workers who may well just decide to retire instead of breaching the LTA.

‘Given all the problems, the LTA will not even provide the sums the government is looking for to make a dent on the black hole in the public finances.

‘Instead, it simply adds more complexity to the retirement planning process and could add to the brain drain in key public services like the NHS.’

He went on: ‘The whole point of equalising the rate of pension tax relief would be to save the Exchequer serious amounts of money.

‘But in reality moving to a flat rate of relief is a radical overhaul of the system of pension taxation and will take a long time to implement, with all manner of challenges to overcome before any savings could be made.

‘It will hardly be the quick fix to raise some serious cash.’

Browne adds: ‘Although lacking in detail, a taxation on employer contributions looks to be the most politically appealing for the Chancellor given that it does not immediately impact the electorate.

‘But look beneath the surface and it’s likely employers may seek to offset the additional tax burden by reducing their net contribution, perhaps meaning employees will have a lower overall pension contribution.’

Becky O’Connor, head of pensions and savings at Interactive Investor, says: ‘We need more not fewer incentives to invest for retirement.

“Tax relief and employer contributions are two benefits that make pensions the best way for most of us to put money aside for the future.

If the Government chops away at them, workers face poorer outcomes in retirement. This could translate into more pressure on public services from a less financially secure older population in years to come.

‘The Government should think hard before yanking away some of the few tools people have to look after themselves in old age.

‘People are also more switched on to their pensions these days.

‘So while pension tax changes might be seen as a clever policy move that wouldn’t attract too much negative attention in former times, now, with workers paying more attention to their retirement pots, any tinkering could be more unpopular than expected.’

‘Curbing incentives means some people could also use pensions less and choose other ways to invest for retirement instead.

‘It could become a free-for-all, with people taking more risks than might be appropriate on other investments to try to make up for any reduction to these benefits.’