The countdown to the Autumn Budget is on, with chancellor Rachel Reeves set to deliver her statement on 26 November. Weak growth, high borrowing costs, and failed spending cuts will make it a tough task, with tax hikes widely anticipated.
Given that Reeves has ruled out increases to income tax, employee National Insurance (NI), and VAT – the three main sources of revenue – pensions could be a tempting area to consider.
Pension tax relief is a frequent area of speculation given it costs the government around £50 billion per year. However, former pensions minister Steve Webb warned that cutting this tax incentive could prove complex and politically dangerous.
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“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,” Webb said.
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“The political backlash against such reforms could easily echo previous ‘Omnishambles’ Budgets where a U-turn was made within a matter of weeks,” he added.
Webb also highlights pension tax-free cash and salary sacrifice as two other tempting but politically-dangerous areas. It is worth noting that the Treasury has not confirmed anything and does not comment on Budget rumours, however both areas have garnered attention from industry experts.
We take a closer look at the possible measures and the dangers of each.
Cutting the higher rate of pension tax relief
To encourage people to save for retirement, HMRC gives tax relief on pension contributions up to an annual limit of £60,000. This is applied at your marginal rate – 20%, 40% or 45%. It means a £100 pension contribution only costs a basic-rate taxpayer £80 of post-tax income, £60 for a higher-rate taxpayer, and £55 for an additional-rate taxpayer.
While it is a valuable incentive, pension and NI tax relief cost the government £52.5 billion in 2023/24, according to HMRC figures published in July.
Some also argue high earners shouldn’t be entitled to full tax relief. Alternative proposals include getting rid of the higher rates of tax relief (i.e. entitling all taxpayers to just 20%), or introducing a flat rate for everyone (for example, 30%).
LCP warns against cutting pension tax relief, arguing that it would constitute a major structural change to the pension system, requiring complex updates to administrative and payroll systems. This could make it difficult to raise any revenue from the policy during this Parliament.
When the idea was rumoured in the lead-up to last year’s Autumn Budget, one expert told MoneyWeek the only way to claw the money back from some pension schemes would be to impose a separate tax charge. This is because ‘net pay’ schemes take your pension contribution from your pre-tax pay. This is different to ‘relief at source’ schemes, where the tax is claimed back at a later stage.
Commenting at the time, Tom Selby, director of public policy at AJ Bell, told MoneyWeek: “If, for example, the government decided to set flat-rate pension tax relief at 30%, anyone [in a net pay scheme] earning more than £50,270 (the higher-rate income tax threshold) would be hit with a tax charge to reduce their automatic tax relief from 40% to 30%.”
“If a higher-rate taxpayer had paid a £10,000 contribution to a net pay scheme in the tax year, they would presumably need to pay a £1,000 tax charge to reduce their tax relief to the required 30%,” he added.
The changes could also prove unpopular with public sector workers. “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,” LCP said.
Trimming pension tax-free cash
When you turn 55, you are entitled to take 25% of your pension pot as tax-free cash, up to a maximum of £268,275 – known as the lump sum allowance. It is a popular benefit and widely understood.
The Telegraph recently said Reeves was considering cutting the allowance in this year’s Budget as part of an extensive list of money-raising proposals. However, its report also cited a Whitehall official who called reforms “unlikely”, suggesting speculation should be taken with a pinch of salt.
Similar rumours last year prompted savers to rush into taking their tax-free cash, with withdrawals surging 61%. Taking it without a plan can have negative consequences, including missed opportunities for further investment growth.
Capping tax-free cash this time around would not be a straightforward policy, as those approaching retirement would almost certainly see it as moving the goalposts. “In our view extensive transitional protections would be needed, and these would mean that extra revenue from this measure could be negligible in this Parliament,” LCP said.
Scaling back tax relief on salary sacrifice
Under current rules, employees can give up a slice of their pay in exchange for a benefit, such as a pension contribution. It is a tax-efficient arrangement, because it means you pay less income tax, and both you and your employer pay less National Insurance.
In May, a HMRC report was published looking into the possible outcome of changing the rules. The report was commissioned by the previous government in 2023, but it has raised fears that existing tax reliefs could be scaled back.
LCP argues that such a change could undermine pension saving and confidence in the system.
While cutting the higher rates of pension tax relief and trimming the lump sum allowance would largely impact wealthier pension savers, salary sacrifice is something that is accessible to those with less wealth too, provided they are willing and able to divert a portion of their current pay.
“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,” said Tim Camfield, principal at LCP.
“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.”
