Chancellor Rachel Reeves should avoid tampering with pension tax reliefs but could change the treatment of inherited pension pots, the Society of Pension Professionals (SPP) said today.
In a new report, the industry body discussed the wide range of changes to pension taxes which Reeves is rumoured to be considering ahead of the budget, warning there were “no easy solutions”.
In particular, the report took aim at calls to introduce a flat rate of relief on pension contributions.
Under existing rules, contributions attract income tax relief in line with the person’s marginal tax rate. Pension distributions are then taxed as the pot is drawndown.
The relief exists to encourage people to save for their retirement. HMRC has put the cost at £48.7bn for 2022/23, and many think tanks have suggested the rules could be reformed, potentially saving billions.
However, the SPP said the true cost of tax relief was likely to be “considerably smaller” than the figures imply.
HMRC’s figures net off the income tax being paid by pensioners at the moment against the relief provided to savers, but the report noted that pensioners’ income tax receipts “bear little or no relation to the reliefs currently being provided”.
“The income tax eventually paid by the cohort currently receiving relief is likely to be far greater, due to the higher value of the pensions in payment and the increased number of individuals receiving taxable pension benefits,” it said.
It warned that changing pensions tax relief would be “incredibly complex, time consuming and costly” and would be “unlikely” to raise the sort of sums Reeves needs.
The SPP’s paper comes just a day after Reeves reportedly dropped plans to introduce a flat rate of relief out of fear that it would disproportionately impact public sector workers.
But the body also warned against limiting the tax-free lump sum, which allows savers to withdraw 25 per cent of their pension tax-free up to a limit of £268,275.
It argued that restricting the lump sum would “decrease trust and confidence” and act as a disincentive to save.
However, the SPP did suggest that the treatment of pension pots at death could be reformed.
Pension pots are not counted as part of the estate for inheritance tax, unlike housing wealth or other savings, and can, therefore, be passed on tax-free.
“This is anomalous to the payment of a dependant’s scheme pension, which is taxed as income… and is therefore a potential area to target,” the report said.
The Institute for Fiscal Studies (IFS) suggests this measure could raise hundreds of millions of pounds.