Chancellor of the Exchequer Rachel Reeves may have struck a positive tone in her speech at the Labour Party conference but pension savers and taxpayers remain wary of the signposted ‘painful’ Budget ahead.
In her speech at the Labour conference, Chancellor Rachel Reeves stressed that “tough” decisions would need to be made to plug the £22 billion “black hole” in government finances, stoking speculation that a tax raid could be on the horizon.
While Reeves has vowed that there will be “no return to austerity”, the Office for Budget Responsibility has warned that UK debt is on an unsustainable path, suggesting that without significant tax rises, the country faces spiralling public debt.
Tom Selby, director of public policy at AJ Bell, said: “While the chancellor’s tone may have been more positive, she left the conference in no doubt that painful decisions are coming in the Budget on 30 October, although the country remains in the dark on where exactly the axe will fall.”
According to Rachael Griffin, tax and financial planning expert at Quilter, the Government has “little choice but to invest in growing the economy at a faster rate”, without which tax revenues will not keep up with spending requirements.
Griffin said one of the key strategies involves keeping tax thresholds frozen for the next three years, which will continue to raise revenue as earnings increases.
Inheritance tax relief
There has been growing speculation in recent years that inheritance tax (IHT) relief could fall onto the chopping block in a bid to boost government coffers.
Griffin said Labour may reassess IHT relief, particularly Agricultural Property Relief (APR) and Business Relief (BR). However, she warned that cutting APR or and BP could have unintended consequences for key sectors, with farmers and small business owners facing higher tax burdens, reducing their ability to maintain or transfer their businesses.
Griffin said rather than forcing people to pay more tax, Reeves should seek to simplify the current system.
“If Labour maintains the status quo for inheritance tax and its associated thresholds or even opts to make it more punitive, then it must balance this with modernising gifting laws. There are hundreds of IHT reliefs, and the system is ripe for simplification but that should not necessarily mean that more people have to pay IHT. A fairer more equitable system could be something that Labour feel they can get behind,” she said.
“Additionally, simplifying the system would decrease confusion and provide greater flexibility for estate planning. Striking a balance between supporting family businesses and simplifying IHT aligns with Labour’s goal of fostering a more productive UK economy and presents a balanced option for the party this autumn.”
Pension reform
Most Budgets are preceded by speculation that pension tax perks could come into the firing line, but while there are a number of potential options open to the government, they all come with “significant practical and political challenges”, says Selby.
Arguably the most controversial is speculation that the government will restrict the 25% tax free cash lump sum.
Selby said such a move would be “deeply unpopular” and undermine wider government efforts to boost long-term investing.
Selby said: “It would inevitably be hugely complicated, as those who have already built-up entitlements to tax-free cash under the existing rules would almost certainly need to be protected against a retrospective retirement tax. Furthermore, the overall amount people can access tax-free has already been scaled back significantly over the last 14 years, and if the current figure remains frozen, it will continue to be eroded in real terms.”
Meanwhile, Griffin warned that decisions such as these, if implemented without consultation and clear communication, could lead to a rush of ill-considered withdrawals.
Griffin said: “The government must provide clarity on what pension-related changes are not in scope to prevent poor decisions, particularly as any significant reforms could have long- lasting effects on retirement planning. Denying access to previously promised benefits would cause distress among savers, many of whom have structured their entire retirement strategies around the existing rules.
“By offering clear assurances and communication ahead of the budget, the government can help retirees avoid making rash, ill-advised financial moves as we are seeing from some at the moment, that could have ramifications for someone’s entire retirement.”
There is also speculation that the government could introduce a flat rate of pension tax relief, which in its most extreme form could see relief restricted to the basic rate of 20% for all, a move that could raise billions of pounds of extra revenue for the Treasury. However, this would create several challenges, with a huge chunk of any potential savings coming from defined benefit schemes, the majority of which now reside in the public sector.
Selby explained: “If a flat rate of pension tax relief below 40% were applied on these schemes, the only way to ensure the correct level of tax relief was applied to contributions from higher and additional- rate taxpayers would be to hit those members with a tax charge likely running into thousands of pounds. This would therefore risk opening up a blistering row with NHS staff and civil servants at a time when many public services are already stretched to breaking point.”
Potential pensions death tax
The tax treatment of pensions on death will be viewed by many as “low hanging tax fruit ready to be picked”, says Selby. Under existing rules, it is possible to pass on your retirement pot completely tax-free to your nominated beneficiaries if you die before age 75. If you die after age 75, any inherited pension is taxed in the same way as income. Importantly, pensions usually don’t form part of people’s estate for inheritance tax purposes.
However, making changes could come with substantial challenges, with the biggest hurdle being how to treat people who have made decisions about their retirement pot based on the pension death tax rules as they currently stand.
Selby said: “It is therefore possible a complicated protection regime would be needed to ensure people are not subject to unfair and arguably retrospective tax measures. This would inevitably reduce the money the Treasury could potentially raise from such a move.
“Given the government’s focus on stability, it would be positive if the chancellor used her Budget to commit to ending the constant speculation and providing long-term certainty around pension tax incentives. Savers are making a long-term commitment when saving in a pension, so a commitment to stability from the government doesn’t feel like too much to ask.”
ISA simplification
Labour recently announced that it would abandon the creation of a “British ISA” in a move that was widely welcomed by the investment industry, who had cautioned that it could create further complexity and confusion in the ISA market.
However, many still believe that further simplification is required.
Griffin said: “Limiting the number of new ISAs and focusing on encouraging investment in higher-return options such as Stocks & Shares ISAs should be high on its list of priorities. This serves multiple purposes; firstly, it helps encourage greater long-term saving amongst the nation and secondly it helps reach Labour’s aim of getting more money invested in UK plc.
“As part of this simplification process Lifetime ISAs need to be looked at as a priority. Renaming the LISA to something like a ‘First Home Account” and removing the retirement element could make the product more attractive and easier to understand. Additionally, reducing the early access penalty from 25% to 20% would give savers more flexibility without punishing them during times of financial hardship.”
Selby echoed the call for simplification in the ISA market, pointing out that it would come at limited cost to the Treasury but potentially encourage millions of people to invest for the long term.
Selby added: “Steps could also be taken to improve the attractiveness of the existing Lifetime ISA. Helping people onto the housing ladder is a clear priority for the new government and the chancellor should iron out the kinks in the design of the Lifetime ISA to make it as attractive as possible to would-be homebuyers.
“Most obviously, the 25% early withdrawal charge is deeply unfair and punishes those for whom a change of circumstances means they can’t pursue their homeownership aspirations. Reducing this to 20%, so it simply aims to return the upfront government bonus, would be a simple, low-cost reform that benefits younger people.”
Child benefit
The outgoing Conservative party pledged to tackle the rules around child benefit where many dual-income households earning just under the cap can still receive full child benefit, while single-earner households slightly above face a reduction or complete loss of the benefit.
Labour has so far remained tight-lipped on whether it will continue with the Conservative pledge.
Griffin said it would be fairer to peg child benefit eligibility to household income under £120,000 rather than individual earners, which would “more accurately reflect the financial realities” of modern families.
She said: “Reforming this threshold would ease financial pressure on families and ensure that the benefit continues to serve its purpose in supporting households raising children, especially during times of rising costs.”
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