Pension saving is currently a great way to save on tax. But the wolf is at the door! Rishi Sunak is planning for the Autumn Budget, and he needs to raise taxes to plug the hole in the government’s bank balance. It’s looking increasingly likely that a pension tax raid is on the cards!
Here, I take a look at why pension savings are currently tax efficient. I also investigate why the chancellor might target pension savings in his Autumn Budget and what any tax changes might mean for you.
Pension saving is extremely tax-efficient
Pension saving is currently extremely tax-efficient. That makes it a target for the chancellor in his Autumn Budget. Even small changes would raise a lot of additional revenue for the government.
Here’s why pensions are currently so tax-efficient:
You’re allowed to save into your pension from your pre-tax earnings. If you’re a higher rate taxpayer, that means that it will often only cost you £60 to pay £100 into your pension fund.
You are also currently allowed to withdraw 25% of your pension fund tax free from the age of 55.
If you die with money remaining in your pension pot, then it may be possible to pass it on to beneficiaries without paying Inheritance Tax. If you have a generous defined benefit scheme and don’t need to dip into your additional pot, then this could be great news. You might be able to use your pension pot to shelter your estate from Inheritance Tax. The rules are complicated, so you should check with a financial adviser or a solicitor to see if this applies to you.
Why Rishi Sunak might target pensions in the Autumn Budget
The government is broke. Spending during the Covid-19 crisis reached record levels and the chancellor is looking for ways to raise tax revenues in his Autumn Budget.
Here’s why I think he is likely to raid our pension savings by reducing tax benefits for pensions:
Tax relief on pension contributions is very expensive. It currently costs the government around £40 billion per year. Even small changes in the rules could reap big rewards for the government.
In September, Rishi Sunak announced a 1.25% National Insurance rise. It was an unpopular move and he was widely criticised for increasing taxes for the poorest workers. He is therefore unlikely to announce more Income Tax or National Insurance hikes. He needs to find other areas to increase tax revenue.
The government loves stealth taxes. They can raise tax revenue by adjusting already complicated rules without attracting much attention.
Tax relief on pensions is more generous for better-paid workers. That’s because higher rate taxpayers get back 40% tax on their pension contributions, whereas lower-paid workers only get 20% tax relief. Changing to a flat rate of tax relief on pensions would fit with the government’s ‘levelling up’ agenda. They could market it as a fairer tax system.
What Autumn Budget rule changes might mean for you
Here are some pension rule changes Rishi Sunak could make in the Autumn Budget:
Abolish higher rate tax relief on pensions. This would mean that everyone gets 20% tax relief on their contributions rather than richer workers getting 40%. If you are a higher rate taxpayer then this would make pension contributions less tax-efficient. If you contribute £10,000 per year (before tax) to your pension then it would cost you the same to contribute only £8,000 per year after this rule change.
Reduce the amount you can take tax free from your pension from 25% to 20%. This would mean that someone with a pot of £400,000 gets the first £80,000 tax free rather than £100,000.
Introduce Inheritance Tax on pension pots. This would mean that more people pay Inheritance Tax when they inherit from their relatives.
Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
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