According to the Labour Party, there is a ‘black hole’ in public finances left unaccounted for by the previous government to the tune of £22 billion.
This applies to the current financial year alone – and as the Office for Budget Responsibility (OBR) is yet to publish the official figures, the total could be even bigger.
For Chancellor of the Exchequer Rachel Reeves, finding the money to cover this shortfall means making controversial decisions like cutting winter fuel payments for pensioners and potentially increasing taxes.
With the Autumn Budget due at the end of October, which Prime Minister Keir Starmer has said will be ‘painful’, there are plenty of suggestions from think tanks on how to raise the billions needed to fill the gap.
This includes a report from the Fabian Society – one of the original founders of the Labour Party – that suggests the government could raise £10 billion a year by reforming pension tax.
Read on to learn more about their proposals and how changes like this could affect you if the government decides to implement similar policies as part of the Budget.
What could pension tax relief reforms involve?
Pension contributions are mostly exempt from tax, meaning most workers will receive more in tax relief on their pension investments than they will be taxed on their pension income – especially high earners.
This is therefore a key area to introduce reforms in a Budget focused on raising revenue.
At the end of August 2024, the Fabian Society published a taxation report titled Expensive and Unequal: The case for reforming pension tax relief.
The report suggests changing tax reliefs on pension contributions by:
- Creating one flat tax relief rate for all tax bands, which would apply to both individual contributions and employer contributions.
- Increasing tax on pension lump sums, charging National Insurance on private pensions, and charging Inheritance Tax on pension assets.
- Consulting on National Insurance Contribution reforms for pension contributions, including both employee and employer NICs.
- Recycling savings made by these changes into increasing minimum employer contributions, developing an opt-out pension for self-employed workers, and providing pension credits for carers.
Together, these reforms could raise £10 billion annually – compared to the £1.5 million that means-testing winter fuel payments is expected to raise in 2025–2026.
The new system should be simple to follow, incentivising individual and employer pension contributions while keeping tax reliefs proportionate to earnings.
How would a flat rate of pension tax relief be beneficial?
The most significant part of the Fabian Society’s proposals is the idea of introducing a flat rate tax credit instead of Income Tax relief for pension contributions.
This plan was allegedly once considered by George Osborne, the former Chancellor of the Exchequer for the Conservative government between 2010 and 2016.
HMRC figures from the 2022–2023 tax year featured in the report highlight issues like only 1/3 of pension tax relief being offset by tax revenue from pension payments, and inequalities like the majority of tax relief on pension contributions going to higher earners, employers, and men.
Reducing the tax benefit for higher and additional rate taxpayers, who receive over half of pension contribution tax relief despite earning the most, will help to generate revenue for the Treasury.
As an example, a higher-rate taxpayer would currently contribute £60 to pay £100 into their pension with tax relief. Under the Fabian Society’s proposal, contributing £75 from net income would be topped up by a £25 tax credit instead to bring the total to £100 – like a Lifetime ISA.
It would benefit most taxpayers because it would reduce the net cost of their pension contributions.
Should you be making changes to your pension plans?
It’s likely that the Treasury was already considering most of the tax-raising ideas presented in this Fabian Society report, but we must wait until 30th October to find out whether the government will be introducing any pension tax relief reforms in the Autumn Budget.
Even if it turns out that these measures aren’t included in Labour’s plans to fill the ‘financial black hole’, it’s still worth noting they could happen in the future when considering topping up your private pension.
With the cost of retirement and State Pension age both rising, it’s essential to review your pension contributions and start planning for retirement to build your savings effectively.
If you need financial planning advice to help you optimise your retirement income without maximising your tax liability, why not speak to our Barnsley accountants?
Here at gbac, we provide a wide selection of accounting services, so call us on 01226 298 298 or email us at info@gbac.co.uk to learn how we can help you with efficient pension planning.