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Numerous rumours have been circulating about the forthcoming budget. In this article, we concentrate on pensions and some of the options available to the Chancellor.
Using case studies, we demonstrate how the outcomes might affect you and what action you could take.
As you may already know, pensions provide a tax-efficient way of saving for retirement. Currently, pension contributions benefit from tax relief and the funds within a pension grow free from capital gains tax and income tax. Pensions can also benefit from attractive death benefits.
There are number of options which could affect the current pension regime including:
- Reduction of tax relief on pension contributions.
- Changes to tax-free cash rules.
- Changes to the inheritance tax treatment of pensions
1. Tax relief on pension contributions
| Case Study: Harry, aged 53, earns £195,000pa gross. He anticipates retiring in 8 years. |
Harry makes a personal pension contribution of £15,600 into his workplace pension and his employer also contributes £15,600. He is an additional rate taxpayer (ART).
Current situation:
Harry can get basic rate 20% tax relief on personal pension contributions up to 100% of his annual earnings. He can also claim higher (HRT) and additional rate tax relief on any income he has paid 40% and 45% tax on respectively.
On Harry’s net pension contribution of £15,600:
| Net pension contribution | Government tax relief | Additional tax relief
(HRT & ART) |
Effective cost to Harry |
| £15,600 | £3,900 | £4,875 | £10,725 |
With a net personal contribution of £15,600, the government adds 20% basic rate tax relief of £3,900. As an additional rate taxpayer, Harry can claim a further £4,875 via his self-assessment tax return. This means that the effective cost to Harry of his pension contribution is £10,725.
Although a high earner, Harry is not affected by the Tapered Annual Allowance (TAA) which kicks in for those earning over £260,000 adjusted income in the current tax year (£240,000 in 2020/21 to 2022/23 and £150,000 in 2019/20). This means that his 2024/25 annual allowance for pension contributions is £60,000 gross.
Harry’s total gross pension contributions for 2024/25: £35,100
Remaining 2024/25 allowance, gross: £24,900
What could happen in the budget:
One option is the reduction of tax relief on pension contributions. For example, to a flat 30% rate of tax relief for everyone or capped tax relief at 20% i.e. the current basic rate of tax relief.
This means that post-Budget, Harry may no longer receive any or all of the additional tax relief on his personal pension contributions.
Action Harry could take ahead of the Budget:
As Harry is trying to build up his pension funds prior to retirement in 8 years’ time, he should consider making full use of his pension allowances prior to the budget.
In addition to his remaining allowance in the current tax year, Harry has unused carry forward allowance (there are rules for carry forward). Based on his contribution history over the past 3 years (£35,100pa gross), he has available carry forward of £59,600 gross. Based on his salary, he is able to fully utilise this carry forward allowance. In addition, Harry can afford to do so.
| Net pension contribution | Government tax relief | Additional tax relief
(HRT & ART) |
Effective cost to Harry |
| £47,680 | £11,920 | £14,900 | £32,780 |
By topping up his pension contributions and investing with an average growth rate of 6%pa, a contribution that cost Harry £32,780 could be worth £100,693 in 8 years’ time when Harry retires. This is equivalent to an increase of 114%.
2. Changes to Tax Free Cash (TFC)
| Case Study: Jane, aged 61, who retired last year but has not accessed her money purchase pension, valued at £630,000. |
Jane does not need to use her pension to cover her own day-to-day living expenses. However, she is considering gifting to her adult daughter to help with a home extension and school fees.
Current situation:
As Jane is over the age of 55, she could draw up to 25% of her pension as tax free cash (TFC), capped at £268,275. Her full TFC is £157,500 and she has not taken any other TFC.
However, taking the TFC, would bring the funds into Jane’s estate (unless spent) for inheritance tax purposes. If a death benefit nomination is in place, pension funds are currently outside of the inheritance tax regime.
What could happen in the budget:
One option circulating is that the amount of TFC may reduce, for example, be capped at a limit such as £100,000, or be removed altogether.
This means that post-budget, Jane may no longer be able to use this option for gifting the required amount to her daughter.
Action Jane could take ahead of the Budget:
As Jane is already considering gifting to her daughter, she could opt to access the TFC under the current rules before the Budget. She would need to ensure that the gift and subsequent reduction in her pension value would not affect her standard living. After taking the TFC, the value of Jane’s pension would be £472,500. Based on a growth rate of 6% and income escalation in line with CPI, the residual pension funds could provide Jane with a ‘sustainable’ annual income of £22,750 gross in today’s money until age 100.
The gift would be considered a potentially exempt transfer or PET and be subject to the 7-year gifting rule. After 7 years, at age 68, it would be out of Jane’s estate altogether. In the meantime, if Jane were to pass away after 3 years, the gift would benefit from taper relief.
3. Changes to IHT treatment of pensions
Pensions can be a valuable tool for clients seeking to mitigate their IHT liability. As under current rules, pension money can be passed on to beneficiaries without any inheritance tax. If death occurs before age 75, then no tax applies, and if after age 75, then the beneficiary will pay income tax at their marginal rate.
This is a tricky one to take any action against ahead of the budget. Changing the tax treatment on death of pensions may prove too complicated, in a similar vein to further changes to the lifetime allowance regime. However, the government could make changes to make the system less generous if they wanted to.
Financial advice post-budget may be the best way to help you achieve your goals regarding your pensions and IHT liability.
Summary
In summary, the Chancellor could make any number of changes to the pension regime. It is important to take financial advice before taking any action and, in general, anything you do ahead of the budget should reflect what you would have done anyway but just bringing the timeframes forward.
If you would like to talk through your options, please get in touch with us via 020 7469 6830 or info@ipscap.com
This document is issued by IPS Capital LLP of 4 Eastcheap, London EC3M 1AE; a limited Liability Partnership registered in England OC328405 and authorised and regulated by the Financial Conduct Authority (Financial Services Register 471375).
This document is for retail and professional persons and intermediaries based in the UK only. This publication does not constitute advice and you should not make any investment decision based on it. The information contained herein is correct to the best of our knowledge and we may not be held liable for any errors, inconsistencies or future amendments to tax or pension laws. This information is based on current information in respect of UK tax and pensions. IPS Capital LLP does not offer tax advice and you should seek professional tax advice for your own circumstances. Our opinions may change without notice.
Lucy Chahil, Senior Wealth Planner
lchahil@ipscap.com
