Are more Labour pension tax changes likely?

An internal memo sent by deputy Prime Minister, Angela Rayner, to Chancellor Rachel Reeves ahead of this year’s Spring Statement has ignited renewed concern that further tax rises lie around the corner.

The leaked document calls for up to £4 billion of tax hikes on top of those unveiled in last year’s Autumn Budget. While it wasn’t something Ms Reeves took heed of, and there is no suggestion yet any of the measures spanning dividends, inheritance tax, stamp duty and pensions will become reality, there is a risk the proposals remain a bone of contention in Westminster.

Labour pension lifetime allowance reintroduction?

One of proposals in the memo was for the pension lifetime allowance (LTA) to be reinstated. The LTA is the total amount an individual can build up in UK pension schemes without incurring a tax charge, typically tested when taking benefits for the first time or upon reaching 75.

The cap was previously set at £1.073m before being abolished by the Conservative Chancellor, Jeremy Hunt, as part of the 2023 Spring Budget. Labour had at one point said it would reintroduce the LTA should it win the 2024 General Election, but it then scrapped the idea.

With a limit to the annual allowance, which is particularly strict for high earners, as well as the removal of pensions from preferential inheritance tax treatment from April 2027, it seems unnecessary to consider reintroducing the LTA. What’s more, the current system already results in a progressively higher tax burden on combined pension pots significantly over £1m – thanks to the legacy the previous LTA left behind.

When the lifetime allowance was abolished, it spawned with three replacement allowances for larger combined pots – the lump sum allowance, the lump sum and death benefit allowance and the overseas transfer allowance. The latter two were set at the previous level of the lifetime allowance, £1,073,100. Meanwhile the tax-free element of certain lump sums was capped at £268,275 – 25% of the LTA – for those without previous pension ‘protections’.

This remaining monetary limit on tax free cash, combined with restrictions around death benefits and transfers overseas, makes building large pension pots less attractive – even before considering the new inheritance tax changes. A reprise of the LTA would reintroduce the element of double taxation that made it so despised before. It would seem like a huge overkill given the guardrails of the replacement allowances, as well as the risk of public trust in the pension system being further damaged. As a result, it might put people off building bigger pension pots, which could reduce the tax take compared with the current scenario of benefits effectively tapering off.

Any move would also resurrect the problems around NHS professionals where the LTA had frequently been cited as an obstacle to remaining in the workplace. Defined benefit pension schemes are usually valued at 20 times the pension income in the first year plus any lump sum, so a comfortable but hardly lavish pension of just over £50,000 a year had historically been caught by the limit of just over a £1m. Therefore, it wouldn’t make any sense bringing back the LTA at that sort of level.

Fortunately, an LTA comeback doesn’t seem likely. There appears to be general parliamentary consensus that a simple, stable pension regime is supportive of self-reliant retirement provision. Pensions also stand to play a valuable role in the government’s wider aims to boost UK investment and constant tinkering to the pension rules undermines that.

What matters most for people planning for their futures is consistency of policy. Repeatedly re-writing the rules creates a complex, uncertain landscape that weakens confidence. The permanent removal of the lifetime cap is an important sign of stability, allowing people to plan their retirement effectively, so we wouldn’t expect a U-turn, though it’s not possible to rule anything out

Read more: What is Pension Relief Tax?

How likely is a Labour tax-free pension lump sum change?

The 25% tax-free lump sum on retirement, also known as the Pension Commencement Lump Sum (PCLS) is a well-known benefit of saving into a pension.

With personal pensions such as a SIPP, lump sums can be taken at any time after age 55 currently (57 from 2028), with the first 25% usually able to be taken tax free and the remainder taxable. However, as mentioned above there a cap on tax free cash set at £268,275.

There are no suggestions the pension tax-free lump sum is to be scrapped by the Labour government or even be altered from the current level, but the upper limit could, at least in theory, be a soft target.

As things stand, it stays frozen at this level and provides another example of the fiscal drag that governments are so fond of. As the cost of living rises, the ‘real terms’ value of the tax-free cash limit falls. But it could also be reduced by any politician looking in envy at the amount being released tax free from defined contribution pots. It’s an easier lever to pull from a legislative point of view than the LTA, and the technicalities are lost on the public at large.

Although there is renewed freedom to build up a sizable pot with the removal of the LTA, those with larger pension funds are increasingly finding the advantages around drawing money out, as well as the death benefits, are diluted once the £1m milestone is passed. Not to mention the far less favourable inheritance tax regime that lies ahead. It emphasises that a variety of approaches to retirement income can be necessary, while fully maximising the benefits of pension tax relief.

Read more: Should you save into a pension or an ISA for retirement?