Having described pension tax breaks as “eye-wateringly expensive”, it would be no surprise to see them bear the brunt of the chancellor’s attempts to balance the books at next week’s Budget.
But just because you can do something, it does not necessarily mean you should. Chancellor Philip Hammond should be well aware of this in his long-term pursuit of cost savings to fund the government’s spending pledges in areas such as the NHS.
The chancellor must tread carefully, as any action he takes could have a negative impact elsewhere.
Bold moves in the Budget, such as abolishing high-rate tax relief on pensions, may not go down well politically, while the savings that could be made might still fall short of what is needed.
Thinktank joins calls to save pension tax relief
Switching to a flat rate of tax relief of around 30 per cent might prove to be more palatable, but perhaps ultimately too big a task given that Brexit is still dominating the government’s to-do list.
So what other options does Hammond have and would they be a good move or a big mistake?
Reducing the annual allowance
Individuals are allowed to pay up to £40,000 per year into a pension and receive income tax relief on these contributions.
For Portafina managing director Jamie Smith-Thompson, a reduction here is the most sensible option.
“The alternatives are far too politically damaging. Cutting the annual allowance is a lot easier to implement than making changes to tax relief or going near tax-free cash,” he says.
“If the reduction is realistic and not too radical – for example, squeezing the allowance from £40,000 to £35,000, or even £30,000 – then the government is raising extra revenue without straying from the centre ground.”
But not everyone agrees. As Nexus Investments managing director Matthew O’Kane highlights, surely it is counter-intuitive to tell people to save more for the future while making it harder to do so?
O’Kane also thinks that the caps could be used by employers to justify the adoption of less generous pension schemes.
Altus Consulting principal consultant Jon Dean is concerned too. He suggests that a lower annual allowance could mean the government needing to negotiate higher pay rises to compensate public sector workers.
The verdict? As Royal London director of policy Steve Webb points out, Hammond will be looking for easy measures that will raise money quickly.
“The cut in the annual allowance from £50,000 to £40,000 was achieved with relatively little fuss and a further cut would be simple and politically attractive,” Webb says.
Treasury tipped to cut pension tax relief to fund NHS spending
A taper system already lowers the annual allowance for those receiving taxable income of more than £150,000, resulting in an annual allowance of just £10,000 for those earning £210,000 a year or more.
Webb thinks Hammond may also tinker with this, as there would be little political sympathy for the losers – those on six-figure salaries.
Alan Hardie, director, McHardy Financial
The biggest issue and area where costs could be saved is the fact the state pension is available to everyone regardless of earnings. It annoys me. When the state pension was introduced, it was to support people who needed it, not those who have other pension income of £150,000 a year.
Means testing of the state pension needs to happen. It’s the elephant in the room. You could taper it for wealthy people, not giving them the full amount until age 75, because they don’t need it.
Lowering the lifetime allowance
The limit on how much can be paid into a pension without incurring a tax charge has fallen from £1.8m in 2010 to £1.03m today.
Could Hammond look here for his much-needed funds? Thankfully, most commentators think he will steer clear.
Menzies Wealth Management chief executive Ben Simpson says: “The chancellor will need to weigh up the potential impact on public sector staff, some of whom are already challenged by the lifetime allowance in respect of their public sector pension schemes.”
Jonathon Webb, pensions consultant, Montfort
The chancellor will no doubt be under pressure to raise revenues by implementing further stealth taxes on those that choose to save into pensions. What that might look like is pure speculation. We will be analysing all and any fine print with an eager eye.
Tax-free lump sum
One other measure that has been mooted is the reduction or abolition of the tax-free lump sum, but commentators agree that Hammond would be a brave man to interfere in this area.
“Removing or capping the tax-free lump sum would be hugely controversial, removing a benefit that had informed people’s previous financial planning decisions,” says PA Consulting pensions expert Mike Teall.
Should the tax-free lump sum be separated from pension decisions?
“In any case, people would most likely only take a lump sum up to the amount that was tax-free and keep the remainder invested or annuitise. The tax benefit to the government would then be spread over time.”
According to former pensions minister Ros Altmann, the industry should be able to breathe a sigh of relief with regards to the tax-free lump sum at least.
She says: “The Treasury appreciates this is a totemic element of the UK pensions landscape and that changes would severely dent confidence.”