Chancellor Rachel Reeves will have “no easy options” if she seeks to raise some extra cash by reforming pension tax reliefs, AJ Bell warned.
With the Budget fast approaching, Reeves is rumoured to be considering tweaking some of the litany of tax breaks that exist to encourage pension savings.
According to the Fabian Society, a collection of changes to pension tax reliefs could raise as much as £10bn per year.
However, Tom Selby, director of public policy at AJ Bell, said many of the possible reforms come with “significant practical and political challenges”.
One of the most commonly cited options for reform is limiting the amount that pensioners can remove from their pension pots tax free.
Currently, savers can withdraw 25 per cent of their pension tax-free up to a limit of £268,275.
Many influential think tanks have called for this limit to be lowered with the Institute for Fiscal Studies (IFS) suggesting such a move could raise £2bn per year.
But Selby cautioned this would be “deeply unpopular and fundamentally undermine wider government efforts to boost long-term investing”.
“It would also inevitably be hugely complicated, as those who have already built-up entitlements to tax-free cash under the existing rules would almost certainly need to be protected against a retrospective retirement tax,” he said.
Pension death tax?
Many think tanks have also called for pension pots to be brought into the orbit of inheritance tax, which the IFS estimated could raise hundreds of millions.
Under current rules, pension pots are not counted as part of the estate for inheritance tax unlike housing wealth or other savings.
Selby admitted that this was “undoubtedly a generous set of rules”, but still warned that reforms would face challenges, particularly for those who had already made savings decisions based on the current set of rules.
“There will, for example, be lots of people who chose to transfer defined benefit pensions into a defined contribution scheme in part because they wanted to prioritise passing money on tax efficiently to loved ones,” he said.
“If all of a sudden that money became subject to a new pensions death tax, those people would, understandably, feel like the rug has been pulled from under them,” Selby continued.