As insiders say Labor won’t be able to resist a budget raid on your pension savings, experts warn… Loot tax relief at your peril, Chancellor – there would be a costly payback

Insiders say government officials admitted last week that they were shocked by the scale of the anger caused by Labour’s decision to cut winter fuel payments. According to a source at the Ministry of Finance, ministers ‘did not take into account how angry people would be’.

Faced with an angry army of pensioners, industry insiders expect the Chancellor to be more alert to the strong emotions arising from tinkering with people’s pensions.

But that hasn’t stopped Rachel Reeves from focusing entirely on pensions. The consensus among the pensions sector is that they are too rich to be left untouched in the first Labor Budget. Six leading British pensions experts, who regularly meet with government and Treasury officials ahead of the Budget, all agree that pensions are in the crosshairs.

But while rumors are swirling that the Chancellor could focus on tax cuts for pensions, a number of industry insiders tell us that such a move is looking increasingly unlikely.

They tell us that the complexity involved would make it prohibitively complicated, would generate less money for the Treasury than it seems – and would simply not be worth it for the anger it would cause.

Wealth explores why experts think tax cuts for pensions may continue, and what could happen to the ashes instead.

How does the pension tax credit work?

Currently, you receive tax relief for any money you contribute to a pension at your marginal income tax rate. This means, for example, that a taxpayer with a basic rate will receive a 20 percent tax reduction on all money that goes into their pension, a taxpayer with a higher rate will receive 40 percent and a taxpayer with an additional rate will receive 45 percent.

The total cost of tax relief to the Treasury was £48.7 billion last year – so you can see why some believe this is an obvious target for a Chancellor looking to save money.

The easiest way to weaken the tax reduction would be to introduce a flat rate for everyone. Reeves has indicated she would consider a lump sum relief rate of 30 percent. That would mean that taxpayers with higher and additional rates would receive less. But to bring in substantial amounts of cash, this would need to be set at 25 percent or even just 20 percent, experts say.

Think tank Tax Policy Associates has cited a dilution of pension tax relief as the most likely tax target in next month’s Budget, while the Institute of Fiscal Studies estimates a move to a flat rate could raise up to £15 billion a year.

Dan Neidle, founder of Tax Policy Associates, says, “I would say this is way ahead of all the other tax hike candidates, given the large amounts that could be raised and the ease of implementation.”

Why there may be no changes to the tax credit

But ask any pensions expert worth their salt and they will tell you that a lump sum of pension tax relief would be far too complicated to implement.

Tom Selby, director of public policy at stockbroker AJ Bell, said: “It’s a political and practical nightmare.” Lizzy Holliday, director of public affairs and policy at pensions company NOW: Pensions, agrees: “There would be so many unintended consequences.”

A flat rate of tax relief could easily be applied to certain contributions paid by most private sector workers.

But for public sector workers it would be much more complicated – and they could face an income tax increase. This is because these employees are promised a certain income upon retirement based on their salary and the length of their employment. The government must keep this promise.

But if these employees receive less pension tax relief each month, there will be a shortfall in the amount saved annually for their pension.

The leaders in the pension industry we spoke to agree that the only way to close the gap between the amount saved and the amount promised would be for employees to pay more income tax during their working lives.

Millions of doctors, teachers, nurses and police officers would see their take-home pay fall as a result. These are the same workers that Labor has been so desperately throwing money at through wage increases in recent weeks. The political capital that Sir Keir Starmer and Rachel Reeves have gained through their expensive and generous pay deals could be lost by such a move.

Selby says, “We’re talking about imposing huge taxes on millions of workers. I can’t imagine a world where that wouldn’t lead to strikes and strikes, especially from those in the NHS, the police and teachers.’

Neidle admits this is a big ‘catch’ and would complicate any reform.

Steve Webb, former Pensions Secretary and now a partner at consultancy LCP, agrees: ‘Any change to pension tax relief would take years to implement, so the Government would not see any savings for a long time. Public sector workers are the group the government clearly cares about, and they are the workers who would be affected by any reform.”

One option would be for Reeves to rule out public sector pensions. But that would defeat the point: most of the money the government could save by cutting the tax credit would come from the public sector, Selby says.

Public sector pensions already have a reputation for providing far more generous income in retirement than private sector workers can dream of. Any further special treatment would only widen this gap.

One source who until recently worked on policy at the Department for Work and Pensions says they would be shocked if radical changes to tax relief were made without fully consulting the sector.

However, if you are a taxpayer at a higher or additional tax rate and are still concerned about the prospects for tax relief and other benefits, you can make the most of it now, before any changes. But it’s worth making sure that acting now makes sense for your own circumstances, whether or not the Chancellor makes changes to pensions in the Budget – so you don’t regret it if they don’t go ahead.

What else could she do?

There are plenty of other reliefs that experts say would be much easier for Reeves.

One frontrunner is taxing pension pots with inheritance tax – a change that experts say could be implemented overnight. Steven Cameron, of pensions company Aegon, says one option would be to say the first £100,000 of pension savings is free of inheritance tax, but anything above that would attract a 40 per cent tax bill.

A 25 percent reduction in the tax-free pension amount could also be planned. The tax-free money is one of the most attractive features of saving for a private pension. Currently, anyone over the age of 55 can pay out the first 25 percent of their pot without any tax liability.

Left-wing think tank Fabian Society says the government could raise large amounts of revenue by limiting the amount you can withdraw tax-free to £100,000. However, experts say this would not make much money compared to the backlash it would cause.

Another change that seems likely is a national insurance tax on the contributions employers pay to workers’ pensions. Currently, employers pay National Insurance on fair wages. Not charging employers National Insurance on pension contributions cost around £23.8 billion last year.

The Institute for Fiscal Studies says this ‘needs reform’.

Robert Salter of tax firm Blick Rothenberg says: “This seems to me the most likely change.”

But he warns this could lead to employers reducing the amount they pay into their employees’ pensions, or affect future pay increases.