I have been saying for some time now that I suspect the Government has cottoned on to the misalignment of tax privileges in pensions to the wealthy. When people think of tax-relief, they think of the savings they get against income tax (or perhaps corporation tax and national insurance) on contributions. Personal contributions get income tax relief , employer contributions are paid without NI and get corporation tax relief.

But changing the way these reliefs are granted, for instance moving to a flat rate of relief for everyone is a Herculean task, one that is beyond HMT, HMRC and their minions, the payroll industry.

A much easier way of raising money and stemming inequality is by putting an end to the abuse of tax benefits on pension wealth. By limiting the tax-free cash sum to £100,000 (for instance) and by abolishing the tax-free inheritability of a pension pot , the Chancellor would achieve three things.

1. Raise money
2. Reduce inequality
3. Encourage pots into pensions

It is however attacking one of the great pension perks, one that people understand and cherish. This is particularly the case (it is argued) among the Sir Humphreys of the Civil Service) who regard the tax-free cash sum, paid at occupational rates, as a fiscal sacred cow.

Overton’s Window

Overton’s Window is that moment in time when the unthinkable can become policy. It has its hierarchy of opening but some think that Rachel Reeve and Kier Starmer have opened it wide for the forthcoming budget, preparing the nation for some unthinkable measures

Yea, even unto undermining civil servant’s perks.

The window is ajar

When the former Chancellor “abolished” the LifeTime Allowance , he didn’t quite. The LTA lives on as the means to limit the tax-free cash sum which, since his 2023 budget has been capped at £267,175, 25% of the LTA.

What to do if you abolish the LTA altogether? Well you could easily enough put a cap on tax free cash, say at £100,000 which would mean nothing to anyone with a pension pot under £400,000 but raise a great deal from those with big-fat pots.

Which is why Overton’s window is so very ajar for capping tax free cash.

It is also open for doing away with tax-free inheritability of pension pots. The IFS has railed against the lunacy of giving wealthy people a second bite of the fiscal cherry by allowing pension pots to be inherited tax-free before 75 and still benignly after that.

The impact of this concession, as with tax-free cash, is to stop pensions being used as an  income that lasts as long as you do  on exchange for them being the “money you spent last”. So for those who have independent wealth to last them through retirement, pension wealth – with all its attendant tax-perks becomes EEE (exempt-exempt-exempt).

I can see no good reason for this inheritance tax exemption whatsoever. It is pernicious to the common purpose of pensions “dignity in retirement from a wage that lasts as long as you do” and it benefits only those with wealth enough to pay inheritance tax in the first place (around 4.4% of those dying in Britain today)

So less than one in twenty-five of us have any use for a pension pot inheritability perk and yet it is seen as another sacred cow that cannot fit through Overton’s Window. Pah!

The FT ran a poll at its recent weekender at Kenwood House, Claer Barrett has collated the results. Here’s what their wealthy audience feared most from Rachel Reeves “painful” budget at the end of October

I believe these are in order of concern though they may be in order of comprehension. It is a list of perks that the rich enjoy, it does not include “benefits” because the rich don’t benefit from benefits (unless you count the state pension a benefit which it isn’t -it’s earned).

The wealthy are feeling vulnerable  about realisable assets (CGT), bequeathed assets (IHT) and wealth accumulation schemes (Pension and ISA savings schemes). They are also concerned about property taxes. And they are worried about their tax-free cash perk (though I suspect less so because many people who have tax-free cash have grabbed it as a means of forestalling the inevitable or as part of the BAU of retirement).

The argument against

Some argue that without a full tax-free cash entitlement and without pension pot inheritability, the rich would stop saving into pensions.

I suspect that pensions will become temporarily less attractive to the wealthy and their wealth managers. The numbers of the wealthy by-passing wealth management and exchanging pensions for annuities and scheme pensions would increase and the attraction of flexi-access income drawdown will decrease.

The argument against squeezing the wealthy with pension wealth taxes is all about the immunity of the wealthy from shouldering the cost of the national debt. It could be argued that we have suffered enough with the freezing of higher rate tax-thresholds, it could be argued that this is a tax on aspiration , it could be argued that Overton’s Window has stayed shut on such reforms for a number of generations.

The argument for

But for those of us who don’t have (say) £400k in their pots or an inheritance tax to leave or come, the impact of abolishing free-inheritability or limiting tax-free cash to £100k will be minimal. Anyone planning on paying off debt with a tax free pension sum will suffer, but that was never a good plan (even if its what I’ve done). This is precisely the opposite demographic who will feel the impact of the loss of winter fuel payments – here is a quid per quo.

Ending the Inheritance loophole  could (according to the IFS)  raise several hundred million pounds a year in the short term, rising quickly thereafter (potentially to as much as £2 billion a year, though probably less) as the introduction of ‘pension freedoms’ in 2015 means more and more people will be dying with pension wealth.

Reducing the amount that can be taken tax-free from £286,275 to £100,000, for example, would affect about one-in-five retirees (and almost half of those who had been employed in the public sector) but would mean about 40% of pension wealth lost the benefit of the tax-free component. Such a change would raise around £2 billion a year in the long run (40% of the long-run revenue yield from abolishing the tax-free component completely)

Finally, and this is underplayed, the reduction of wealth privileges will go some way towards encouraging another of the aims of Government, the use of pension pots as a means to pay pensions, an insurance against old age and a means of returning money to the economy rather than globally orientated wealth management programs. Fiscally incentivised pension savings need to be recycled into the real economy.

Relatively painless tax-reform

I am not into gratuitous hammering of the rich, but I see sense in limiting pension wealth perks, I see Overton’s Window as open and I expect the Chancellor to jump straight through it.