Labour’s first Budget in over 14 years is now within touching distance. Set to be delivered on the eve of Halloween, the event has been suitably shrouded in doom and gloom with prime minister Keir Starmer warning that the fiscal event will be “painful” and involve “tough decisions”.
It comes after chancellor Rachel Reeves accused the previous Conservative government of leaving a £22 billion shortfall in the public finances. More recently, commentators have suggested Reeves may be looking to raise £40 billion through tax rises and spending cuts to close a “funding gap” going forwards.
The good news is that Labour has promised it will “not increase taxes on working people”, which means no hikes to income tax rates, employee National Insurance contributions or VAT.
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The bad news is that workers and pensioners will find themselves paying a larger tax bill regardless – primarily as a result of frozen personal tax thresholds and the effect of fiscal drag.
Thresholds have been frozen since 2021 – an attempt to balance the state’s books after an intense period of government spending during the Covid pandemic. They are set to remain at current levels until 2028, despite the intense period of inflation we have experienced in recent years.
The Office for Budget Responsibility (OBR) highlights the widely-felt impact of fiscal drag in a recent report. It says: “By 2028-29, there are expected to be around 3.7 million more taxpayers overall, 2.7 million more higher-rate taxpayers, and 600,000 more additional-rate taxpayers than if all allowances and thresholds had been indexed to inflation, and the additional rate kept at £150,000.”
What’s more, speculation is rife that other tax hikes could be in store in the Autumn Budget to help refill the government’s depleted coffers. For example, the government could potentially decide to change the rules around inheritance tax, capital gains tax, or look at reforming the way pensions are taxed.
Will Labour scrap the 25% pension tax-free cash?
In the lead-up to the general election, the Conservatives accused Labour of planning to introduce a retirement tax. In reality, this was largely a case of mudslinging after Labour said it didn’t plan to match the Conservatives’ promise to unfreeze the personal allowance for pensioners. However, it is possible that some of the tax benefits currently enjoyed by pensioners could come under the microscope as Reeves considers ways to boost the country’s finances.
Those with a private pension are currently allowed to draw 25% of their pension pot tax free (up to a certain limit). After this point, they start paying income tax on any withdrawals at their marginal rate. However, as commentators have argued recently, the government could raise revenue by cutting this perk, say to 20%.
The maximum amount you can withdraw from your pension before paying tax (irrespective of the 25% proportional limit) is currently £268,275, known as the lump sum allowance (LSA). Labour could also consider cutting this in an attempt to raise money.
According to a recent Telegraph report, government officials are looking at recommendations by two major think tanks to reduce the limit to £100,000.
“Following the abolition of the Lifetime Allowance, the LSA is no longer linked to any wider legislation and therefore the government could easily reduce the amount of tax-free cash individuals can take from their pensions,” says Nicholas Nesbitt, partner at audit, accounting and consulting group Forvis Mazars.
That said, it is important to remember that nothing will be confirmed until the Budget takes place, meaning any speculation in advance is just that – speculation. Furthermore, any changes typically take time to pass into legislation after being announced in a Budget, meaning savers could get a little longer to process the full implications of any policies that are announced.
With this in mind, savers should be careful to avoid making any rash decisions, as withdrawing your lump sum in one go isn’t always a good idea. Taking the tax-free cash in instalments (i.e. as and when you need it) is often a better route, as it means you can continue to benefit from potential investment growth.
See our article: “Should you take your 25% tax-free pension lump sum in instalments?”
Will pension tax relief be cut?
Pension tax relief has been another big area of focus in the lead-up to the Budget, with some speculating that Reeves could cut this perk for higher earners. However, this now looks unlikely, based on information received by The Times.
Tax relief is currently paid at your marginal rate. If you are a basic-rate taxpayer, you get 20%, while higher and additional-rate taxpayers are entitled to 40% and 45% respectively.
This is a generous benefit which encourages pension saving. However, the policy is also costly for the government. As a result, it has been repeatedly thrust into the spotlight in recent years in the lead-up to fiscal events. Recent figures from HMRC reveal this measure cost the government £48.7 billion in 2022/23. Almost two thirds of this was enjoyed by higher and additional-rate earners.
Against this backdrop, some commentators have argued that Reeves could consider introducing a flat rate of relief, say 30%, to reduce the policy’s overall price tag. Others have said she could consider cutting the annual tax-free pension allowance from its current level of £60,000.
The former option would be challenging to implement, though, and risk igniting a row with public-sector employees. With this in mind, Reeves may decide to focus on other areas in her Budget on 30 October.
We share further analysis in a recent piece: “Will Labour change the rules on pension tax relief?”
Are inheritance tax reforms on the way?
Inheritance tax is another area that has been in the spotlight in recent days, amid reports the chancellor could be looking to raise more money from death duties.
Laura Suter, personal finance director at AJ Bell, doesn’t think Reeves will hike the rate of inheritance tax given it is already one of the highest tax rates at 40%. “What’s more likely if Ms Reeves did want to change this tax is cutting allowances or whittling away certain reliefs to increase the amount some estates pay,” she says.
For example, last week, sources briefed on Reeves’s Budget preparations told the Financial Times she has looked at extending the seven-year rule on gifting to 10 years. But there are a range of other areas she could consider too, including business and agricultural property relief and AIM shares.
Pension pots could also be in focus, as they are excluded from the inheritance tax net under current rules. Alternatively, the government may look at applying capital gains tax on inherited assets at the point they are passed down to a loved one, effectively resulting in a ‘double death tax’.
We take a closer look in: “Inheritance tax: will you pay more after the Autumn Budget?”
Will Labour hike capital gains tax?
Capital gains tax (CGT) could be another area of focus in the upcoming Budget, after Reeves refused to rule it out in an interview with Bloomberg over the summer.
Under current rules, basic-rate taxpayers pay 10% CGT on investment gains and 18% on gains from the sale of additional residential properties. Meanwhile, higher and additional-rate taxpayers pay 20% on investments and 24% on second properties. The CGT allowance means some profits are tax free, but this has been slashed in recent years from £12,300 to £3,000.
One radical step that the government could take would be to equalise CGT rates with income tax. “The Office for Tax Simplification, now disbanded, has previously argued the CGT exemption was too high and that the disparity between rates of CGT and income tax distorts decision making,” Suter explains.
However, the government is keen to boost private investment in UK companies and higher capital gains tax rates could be seen as a deterrent. What’s more, Suter points out that a CGT hike might not be as much of a cash cow as you would expect. “The government’s own figures show that a big increase in CGT rates could backfire and actually lead to lost revenue,” Suter adds, with investors expected to change their behaviour to avoid paying the tax.
Will the government hike National Insurance for employers?
If the latest speculation is correct, businesses could find themselves paying more in National Insurance contributions after the Budget.
National Insurance is one of the biggest revenue raisers for the government, and reports suggest hiking employer contributions by one percentage point could raise as much as £8.5 billion per year.
The move wouldn’t be without negative consequences, though. If the policy materialises, workers are likely to feel the impact in their back pocket, despite not being targeted by the tax hike directly.
“The concern is that employers may look to mitigate these costs with smaller wage increases, which will impact people’s ability to meet their day-to-day living costs,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.
“There’s also the potential that it will deter them from boosting their contributions beyond auto-enrolment minimums,” she adds.
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