As the Chancellor searches for additional sources of tax revenue ahead of the Autumn Budget, pensions experts LCP says pension tax relief "looks like an obvious place to go for serious money", especially since the Labour government have pledged not to raise rates of income tax, VAT or employee National Insurance contributions.
There’s always speculation on two types of changes – cuts to higher rate relief or capping/scrapping the ability to take 25% of a pension as a tax-free lump sum. In addition, there’s more speculation this year about potential changes to ‘salary sacrifice’ because HMRC published research on that specific topic.
However, LCP says all of them have such serious political or practical issuess that if they were announced in the Budget "they could ‘unravel’ within days, similar to the famous ‘Omnishambles’ Budget of 2012" where high profile measures created a storm of opposition and had to be watered down within weeks.
New analysis from LCP finds that although the Chancellor may think that pension tax relief represents ‘low hanging fruit’, she could find out that it turns out to have a bitter after-taste politically and economically.
LCP says public sector workers, including those on relatively modest incomes but with long service, could be particularly hard hit by the abolition of higher rate relief or the capping of tax-free cash. Although public sector workers make up a minority of the workforce, the generosity of their pension arrangements and the high level of pension membership in the public sector mean we expect they would be disproportionately affected by such changes.
Getting rid of salary sacrifice is the measure that has the most adverse effect on those on modest earnings, with over 3 million basic rate taxpayers set to lose if the change went ahead. LCP believes this "would be a clear breach of the manifesto pledge not to increase tax on ‘workers’, as well as increasing costs for employers".
Abolishing higher rate relief would be a major structural change to the pension system, requiring lengthy consultation with pension schemes and providers and employers, complex legal changes to implement a new system and considerable time to change administration and payroll systems to reflect the new rules; all of this means very little additional revenue would be likely to flow during this Parliament.
Capping tax-free cash would be widely seen as ‘moving the goalposts’ for those who were approaching retirement and had made plans based on the current rules. LCP says "extensive transitional protections would be needed", and these would mean that extra revenue from this measure could be negligible in this Parliament.
Steve Webb, former pensions minister and partner at LCP, said: “Raiding pension tax relief may look superficially attractive for a cash-strapped Chancellor. But lying beneath the surface are multiple traps for the unwary, meaning that reforms might raise far less than expected, break manifesto promises to workers or put additional burdens on employers who are already under pressure. The political backlash against such reforms could easily echo previous ‘Omnishambles’ Budgets where a U-turn was made within a matter of weeks.”
Tim Camfield, principal at LCP, added: “Millions of people on modest incomes benefit from various features of the tax relief system, including the ability to sacrifice salary and benefit from a reduced National Insurance bill. If this measure was scrapped, employees paying basic rate tax and trying to do the right thing by saving for their retirement could well be losers, as well as the employers who try to provide good pensions. Any such change could undermine pension saving and confidence in the system and should be avoided.”
