Five pension changes that could be announced in the Autumn Budget

As the Budget approaches there’s some nervousness about how personal finances might be affected. However, there’s also a lot of conjecture and rumour, so it is best to take a step back and ultimately see for oneself what is announced on 30^th October.

It’s also worth noting that it would be unusual, though not entirely unprecedented, for major changes to occur overnight, which means individuals and their advisers are likely to have some time to digest the consequences.

That said, there may be some major changes ahead and pension savers should be on alert for announcements. It would appear the Chancellor has backed away from the idea of reforming pension tax relief to a flat rate following concerns about the impact it would have on public sector workers. This is good news as it would have resulted in a highly convoluted system and engender a mistrust of pensions as a long-term savings vehicle.

Yet pensions may not escape the Budget unscathed and there are several areas where reform could affect your planning.

Five pension changes that could be announced in the Autumn Budget

1. Employer national insurance on pension contributions

An idea recently surfaced in the press is the possible extension of employer national insurance workplace pension contributions. At present, employers pay national insurance contributions of 13.8% on an individual’s earnings over £175 per week, but pension contributions, including through ‘salary sacrifice’ arrangements, are exempt. It’s an incentive for companies to help their employees provide for their retirement.

Withdrawing this relief could net the Chancellor a significant sum. The Institute of Fiscal Studies (IFS) estimate as much as £17bn a year. However, levying national insurance on employer pension contributions would come with some nasty side effects. It would push up employment costs, and there would be a temptation for bosses to scale back pension contributions or limit pay rises. This could constrain people’s retirement provision when there are already huge question marks around income adequacy and financial resilience for tomorrow’s pensioners. The Chancellor may therefore choose to limit the tax deductibility in some way rather than withdraw it entirely.

Read more: How to follow the Autumn Budget

2. A stricter limit on tax-free cash

Another policy change that is reportedly under consideration is reducing the maximum pension tax-free cash allowable.

Tax-free cash – known more technically as a pension commencement lump sum – is a valuable and widely appreciated aspect of the pension system and a significant reason why saving into a pension is advantageous from a tax perspective. While income and withdrawals from defined contribution pensions such as SIPPs are usually subject to income tax, a quarter of the pot can typically be taken tax-free, up to a limit of £268,275 which is 25% of the now-abolished lifetime allowance.

Labour has previously referred to the 25% tax free lump sum as “part of the retirement landscape” and an alteration to the percentage would seem unlikely. However, a reduction to the monetary amount of £268,275 would be an easy lever for the Chancellor to pull to target larger combined pots without undermining the well-understood narrative around general pension tax efficiency.

Reducing it by a lot would disrupt many people’s retirement plans and be hugely unpopular, so we suspect the Chancellor will show restraint. It could affect lots of individuals in the public sector as well as the private sector, and ultimately that may serve to protect the status quo.

We emphasise that anyone potentially affected by this issue should not rush into a decision. Taking a lump sum from a pension is an irreversible process that involves moving money from a tax-efficient environment to, potentially, a non-tax-efficient one. This can have a significant impact on your retirement income later in life, so acting to pre-empt changes to pension rules could ultimately backfire.

It is also worth noting it is not customary or indeed practical for significant changes to pension rules to happen overnight. It also wouldn’t be fair on people in the process of making potentially life-changing decisions about their retirement. Before acting you should seek professional financial advice or guidance on your options based on your individual circumstances. If this issue is on your mind, why not talk to one of our financial coaches.

Read more: Will pension tax free cash be axed?

3. Inheritance tax treatment of pensions

Pensions are usually exempt from inheritance tax (IHT), but this is a particular area tipped for reform in the Budget. It’s revenue raising potential might be a slow burn for the Chancellor, but it’s widely seen as something of a loophole in the tax system, especially now the pension Lifetime Allowance has been abolished. At present, the rules incentivise people to run down ISAs and other savings in retirement before accessing their pension which can be passed on efficiently to loved ones.

Reform in this area could have significant implications. It could see some people opting to draw down from pension pots faster to make gifts if they are affected by inheritance tax limits. For others it may increase the relative attraction of annuities as a source of retirement income if the death benefits of drawdown are effectively watered down. This is not something that could be brought it overnight, though. Pensions are usually held in trust, so changes to the legal framework would be necessary and would take time.

Read more: Will inheritance tax change in the Budget?

4. Pension annual allowance reduction

With changes to the rates of pension tax relief apparently off the table as a consideration for the Chancellor, there could be renewed focus on the pension annual allowance. This is the maximum amount that can be contributed to a person’s pensions each year to receive tax relief and is dependent on earned income that tax year.

The allowance was raised to £60,000 from £40,000 from the 2023/24 tax year, and if the Chancellor wishes to apply greater restrictions to higher and additional rate relief, she could turn the dial the other way. She might also look to limit the carry-forward rule, which allows individuals to use any unused annual allowance from the previous three tax years, subject to sufficient earnings in the year of contribution and provided they were members of a pension scheme during the years used.

The impediment to significant change in this area could be the need to provide sufficient headroom to high earning professionals with defined benefit schemes, including doctors, who have a high calculated value of pension contributions.

5. State pension increases

This is more of a confirmation than a Budget announcement as the government already has committed to the State Pension ‘triple lock’. This is the mechanism for calculating state pension increases whereby payments rise by the higher of earnings rises, inflation, or 2.5%.

As things stand, pensioners are going to see a decent boost to their income next April thanks to above-inflation wage rises of 4.1%. It’s widely expected this figure will be cemented in the Budget, and this will help make up for the loss of winter fuel payments for most pensioners this November and December.

However, a sting in the tail comes from the freezing of income tax bands, which means more people will start to pay income tax on their State Pensions, particularly those receiving benefits under the old Basic State Pension and have predominantly ‘contracted in’ to the Second State Pension through their working lives. This is set to worsen as thresholds are currently frozen until 2028.

Read more: How do you qualify for the State Pension - and what kind of retirement will it provide?

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