Ahead of this year’s Budget, the Chancellor faces a ‘triple whammy’ of revenue shortfalls, additional spending pressures and political weakness which makes raising headline direct tax rates almost impossible.
As a result he is likely to look again to find savings in areas of public spending which are complex and little-understood and which cost large amounts of money. This makes pension tax relief a prime target. Below we look at why the Chancellor is feeling the squeeze and how pension tax relief could see another cut in the forthcoming Budget.
Latest productivity estimates from the Office for National Statistics suggest that UK productivity growth has been weaker than expected. This is likely to feed through into reduced tax revenue forecasts for the coming year, wiping out a large part of the Chancellor’s room for manoeuvre if he plans to stick to his fiscal targets.
In addition, the Chancellor has a Budget hole caused by two significant revenue-raising measures which were announced and banked but where the policy has since been reversed. These are:
The Chancellor will be looking to find additional revenue to meet spending pressures in several key areas:
By far the simplest way of raising revenue would be to increase the main rate of a big tax such as income tax, national insurance contributions (NICs) or VAT. Following the March 2017 row over NICs for the self-employed it seems unlikely that the Chancellor will return to this area so soon and raising headline rates of income tax or VAT so soon after a General Election would be extremely challenging.
Smaller taxes such as Insurance Premium Tax could rise again, and there is speculation that there will be a new tax on diesel vehicles, all of which suggests that it will not be the high profile areas of the tax system where the Chancellor looks for additional revenue.
The latest HMRC figures suggest that the cost of pension tax relief rose by around £3 billion in the last year. In addition, the cost of not charging National Insurance Contributions on employer pension contributions rose by a further £2 billion. Since 2010, successive Chancellors have cut the various limits for pension tax relief on an almost annual basis, and the present Chancellor is likely to have taken a very detailed look at how much more can be saved on this major item of public spending.
The most likely areas to feel the squeeze are: Pension Tax Relief – what might change?The most likely areas to feel the squeeze are:
Currently, most earners can contribute £40,000 per year into a pension and benefit from tax relief. With contribution limits on ISAs having been raised substantially in recent years to £20,000, the Chancellor will feel he can cut the annual allowance with very limited political fallout.
The most recent cut in the general level of the annual allowance was in 2014/15 (down from £50,000) and that change (combined with a linked reduction in the lifetime allowance) is estimated to raise around £1.1 billion in 2017/18.
One little-noticed reason why Annual Allowance reductions are now more likely is the major reform of public sector pensions. In the past, public sector pensions were based around an individual’s final salary, which meant that someone who was promoted (eg from a deputy head to a headteacher) saw a big surge in their pension rights as their whole service became valued at their new enhanced salary.
A generous annual allowance was needed to avoid such individuals facing a big tax bill when they were promoted. However, public service pensions are now based on a ‘career average’ basis which means that promotions do not create the same surge in pension rights. The Government may conclude that they can now justify a much lower Annual Allowance.
Possible changes: One or more cuts to the annual allowance, perhaps to £35,000 and then to £30,000
From 2016/17 the Government made a further reduction in the Annual Allowance, this time focused on high earners. The rules are complex, but the change mainly applies to those with total taxable income, including the value of any employer pension contributions, above £150,000 per year.
For every £1 of income above this threshold, the Annual Allowance is ‘tapered’ down by 50p until it reaches a floor of £10,000 at incomes of £210,000 or more. When fully implemented (that is, when the ability to carry forward unused annual allowances from earlier years is exhausted) this measure is expected to raise over £1 billion per year.
It seems likely that the Chancellor will be looking to revisit this measure to see if extra revenue can be found. This could be by reducing the £150,000 threshold and/or increasing the taper rate. From the Chancellor’s point of view, the attraction is that this is a complex area which will affect relatively few voters but which could raise significant amounts.
Possible changes: A cut in the £150,000 threshold to £125,000.
As well as an annual limit on tax-privileged pension contributions, there is also a lifetime limit on the size of pension pot which can be built up whilst benefiting from pension tax relief. In 2010 the limit stood at £1.8 million, but this was cut to £1.5 million in 2012, £1.25 million in 2014 and £1 million in 2016.
Each of these changes was accompanied by a complex system of transitional arrangements. As this is an area where Chancellors have repeatedly sought revenue, there must be a chance that we will see further cuts to the LTA.
Possible changes: A cut in the Lifetime Allowance to £900,000
One attraction to the Chancellor of changing the detailed rules around pension tax relief is that the system is not widely understood by the general public and the political impact of changes is therefore much reduced. There are some particular areas where savings might be found:
When an employer pays a wage to an employee, the firm is liable for a NICs rate of 13.8%, but if that money is paid into a pension there is no National Insurance to be paid.
HMRC estimates that that the cost to the Exchequer of not levying employer NICs on employer pension contributions was £15.7 billion in 2015/16, an increase of £2 billion on a year earlier.
Whilst charging full NICs on employer contributions would be a huge change, a ‘special’ new rate could be introduced and could be a significant revenue raiser.
Possible changes: A new 1% rate of NICs on employer pension contributions, raising around £1 billion per year
Commenting on the analysis, Steve Webb said:
At Budget times there is always speculation about the future of the ‘tax free lump sum’ – the 25% of most pension pots which can be taken at retirement without any tax. However, a politically weak Chancellor would find it incredibly difficult to remove this benefit which is one of the few elements of the pension tax relief system which is reasonably widely understood and valued.
He could, in principle, announce that *new* money going into pensions would no longer attract a tax free lump sum, but this would raise little revenue in the short-term and would stoke up alarm that existing tax-free lump sums could be under threat. Even if action on tax-free cash was taken in the Budget it is hard to believe any significant change would command a majority in the House of Commons once the impact on savers became apparent.
‘Since 2010, the Treasury has ‘form’ on raiding pension tax relief on an almost annual basis. With pressure to spend more, especially on young people, and with revenue shortfalls from a stuttering economy, a politically weakened Chancellor is likely to turn again to tax relief as a source of less politically challenging revenue raising.
The annual allowance remains the most likely source of cuts, especially with the increase in the ISA limit, but other aspects of the system may not escape scrutiny. Pension savers must long for the day when pension tax relief is a stable regime which supports long-term planning, rather than an easy source of ready cash for cash-strapped Chancellors’.
Director of Policy and External Communications
Steve Webb is now Director of Policy and External Communications at Royal London. Before this he was Minister of State for Pensions between 2010 and 2015, the longest-serving holder of the post. During that time he implemented major reforms to the state pension system, oversaw the successful introduction of auto enrolment and played a key role in the new pension freedoms implemented in April 2015.