With the Budget just a few weeks away, we are hearing the usual rumours about potential cuts to pension tax relief. So, how likely is Chancellor Philip Hammond to raid tax relief yet again and, if so, which elements of the system look most at risk?
There is no doubt Hammond faces pressures on both sides of his balance sheet.
On spending, the public sector pay squeeze has given successive chancellors a good deal of room for manoeuvre. But now there are signs of a relaxation of the squeeze, pay bills look set to rise considerably. On top of that are the usual pressures of keeping the NHS going, paying for the promises made for the deal with the Democratic Unionist Party, doing more for younger voters and a whole host of other demands for additional public spending.
On revenue, things look challenging as well. Forecasts of productivity growth will be revised down, cutting into the Chancellor’s tax base. In addition, there are policies which have previously been announced and where the Government has banked the cash, but where they were never implemented.
This includes the planned 1 per cent increase in the National Insurance contributions of the self-employed which was announced then reversed, as well as the planned hike in probate fees which never went ahead. These two policies alone were set to raise around £800m per year.
A Treasury minister was recently seen walking up Downing Street with a sheet of Budget options which were partially captured on camera. The document suggested that even a flagship policy such as the raising of tax-free personal allowances could be scaled back. If the Government is looking at significant U-turns of this sort, then we can assume pension tax relief will also be in its sights.
For those of us who spend our time in the world of pensions and advice, the idea of further cuts in tax relief may seem hard to justify. We can already see that a £1m lifetime allowance is far from enough to pay for a life of luxury in old age, and many of those catching up in later life for a pensions shortfall would not appreciate further cuts to the annual allowance.
But the world looks very different from the Treasury. Latest figures show the cost of pension tax relief rose by around £3bn in the last year, while the cost of not levying employer NI contributions on pension contributions rose by a further £2bn. The Government sees tax relief as a bloated area of public spending in need of reform.
In terms of where the cuts might come, the annual allowance is likely to be top of the list. Having increased annual Isa limits to £20,000, the Government may say no one needs to be able to put £40,000 into a pension as well. A reduction to £35,000 or even £30,000 cannot be ruled out.
Linked to this, the complex and messy “tapered” annual allowance could also be in the Government’s sights. A reduction in the threshold from £150,000 per year to £125,000 would raise significant sums and would be unlikely to create a political backlash.
Less likely, but still possible, is a further cut to the lifetime allowance. Although the current lifetime allowance is starting to bite on many people who are not “super-rich”, the Government might feel it could get away with a cut to a figure such as £900,000 without a political storm.
One area where cuts are unlikely is in the pension commencement lump sum. If a chancellor were to tell people who were approaching retirement that they were going to lose 40 per cent of their lump sum, the revolt would make that over the March Budget look like a tea party.
While pension policy and tax policy should be strategic and for the long term, the brutal reality is that pension tax relief has always been – and continues to be – a pot to which hard-up chancellors will return for another dip.
Steve Webb is director of policy at Royal London