In the absence of any meaningful statements on pension policy, the Institute of Fiscal Studies has stepped into the breach and published a paper on how Labour should go about reintroducing capital taxes on pension pots.
The story so far.
In his first budget, Jeremy Hunt abolished the cap on pension wealth that could be accommodated within the standard tax bands. The cap- “the Lifetime Allowance or LTA” meant those drawing cash from a pot valued at more than £1,073,000 had to pay 55% tax till the pot value reduced to below that amount.
The following day Shadow Chancellor Rachel Reeves stated ‘Labour will reverse the changes to tax-free pension allowances. It is the wrong priority, at the wrong time, for the wrong people’
In today’s (4th June) interview with Sky news , Rachel Reeves did not mention reversing the LTA. This may have been deliberate or an act of forgetfulness. But it has not gone unnoticed
No questions asked about cuts to pension tax relief. Labour was today urged by the @TheIFS to go beyond simply reintroducing the #pensions Lifetime Allowance, or cap on how much can be saved, or grow, into a pension over a lifetime and benefit from tax relief. https://t.co/ldUoP7NUiW
— Josephine Cumbo (@JosephineCumbo) June 4, 2024
The IFS are no fans of the pension taxation regime and have put forward a radical alternative, but…
Nothing like our proposed package of reforms has been implemented: the pensions tax regime is still overly generous to those who already have big pensions, those with high retirement incomes and those getting big employer pension contributions (as these escape National Insurance contributions). It remains the case that such a package would represent a major improvement and would be the most desirable course of action for this or any future government.
The IFS’ particular concern is that pension pots are being used to avoid paying inheritance tax.
we currently have ‘the bizarre situation where pensions are treated more favourably by the tax system as a vehicle for bequests than they are as a retirement income vehicle’
The abolition of the LTA only makes this regressive tax break worse.
At first sight…
The report puts forward a series of new numbers
- £2.7m – what the LTA would be if uplifted by inflation when Labour were last in power – but calculated using less favorable factors on DB pensions
- £400,000 – the limit on which Tax free cash can be paid out at 25% – meaning a £100,000 cap
- £0 – the amount that “ideally” could be transferred as a bequest from the deceased’s pension pot.
- A lifetime contribution cap (not specified), which poses an interesting problem for record keepers, especially with some people having multiple jobs.
The report concludes
Absent more radical reform, there is a case for placing a limit on the amount that individuals can accumulate in tax-favoured private pensions. There is therefore a case for Labour’s proposed reinstatement of the lifetime allowance and, were Labour to form the next government, it would be best advised to implement any reform swiftly. It would also be sensible to go beyond a simple reintroduction of the lifetime allowance at its previous level.
One option would be to reinstate the lifetime allowance at a higher value than its old level alongside a reduction in the new limit on the amount of pension from which 25% can be taken free of income tax and a new limit (ideally zero, but any limit would be an improvement) on the amount of pension that can be bequeathed free of inheritance tax.
A reinstated lifetime allowance should also be less generous for defined benefit pensions (relative to defined contribution pensions) than the one that was in place from 2006 to 2022, and particularly so for those who take their defined benefit pensions earlier. It would also be worth considering reintroducing the lifetime allowance as a cap on contributions to defined contribution pensions and accrued benefits in defined benefit pensions, rather than on the pensions’ estimated value.
Forestalling
It is no surprise that the IFS suggest that any changes of these kinds be implemented by a Labour Government as soon after the election as possible.
Were these proposals in the yet to be published Labour manifesto there would be a general run on DC pensions over £400,000 with billions being withdrawn as tax-free cash. There would be howls from public servants still accruing pensions “trapped” in DB schemes and there would be frantic action from deferred members of occupational DB plans, looking to realise cash without delay.
What does the IFS know?
I very much doubt if the IFS speak for the Labour party; but the difference between Rachel Reeves’ ignoring pension taxation and this radical suggestion is likely to prove even more troublesome to advisers than the remarks made at the time of Hunt’s announcement in 2023.
As with VAT on school fees, this is about as sensitive an area to the mass affluent as can be.
Do I see a sly smile on Paul Johnson’s face?
