How to fill the £22bn black hole
Chancellor Rachel Reeves’ first-ever Budget on 30 October will be “painful”, according to the speech made by her boss, Sir Keir Starmer, in the Rose Garden of Number 10 in late August, says Stuart Lamont, financial planner at Waverton Wealth
The Chancellor’s assertion is that she has “inherited” a £22 billion overspend blackhole in the Treasury’s fiscal funds. Whatever the truth of this, she is committed to taking drastic steps to reduce it.
The Chancellor has repeated the commitment made in the Labour manifesto to not increase the “working” taxes of Income Tax, VAT and National Insurance, as confirmed in Hansard.
But the other side of that coin is that – as widely reported – she may target “investment” taxes. She has refused to rule out changes to Capital Gains and Inheritance taxes.
IS THERE AN OBVIOUS PENSION REFORM THAT COULD YIELD AN IMMEDIATE TREASURY BOOST?
The answer to that question is a resounding “yes”. If Reeves were to simply limit the tax relief investors receive on their private pension contributions to the basic rate, then forecasts suggest she could reduce the “black hole” to just £7.5bn.
Indeed, the Taxing Wealth Report 2024 calculated this saving at £14.5bn.The current average annual pension tax relief paid to UK higher rate payers is £8,750. This would fall to £5,450 (according to the same report) if Reeves reduced it to the basic rate of 20 per cent. The financial harvest reaped from such an abundance of “low lying fruit” might prove too much of a temptation for a Chancellor who has already restricted her fiscal options by ruling out traditional tax rises.
Government incentives to boost your retirement pot have always been viewed as particularly generous to higher-rate taxpayers. According to HMRC data for 2022/3 the total cost of paying pension tax relief was £48.7bn. More than double the estimated black hole.
THE CURRENT NUMBERS
Since the devolved government of Scotland exercised its right, in 2018, to control your level of income tax, you may be confused by the plethora of band levels, currently six in Scotland.
If you earn more than £43,663 per year in Scotland, you will pay more income tax than anyone else on that salary in the rest of the UK. Your higher rate is 42 per cent. If there is any silver cloud in the higher rates of Scottish Income Tax it is the fact that, as things currently stand, you will qualify for higher rate tax relief on pension contributions.
LET’S LOOK AT AN EXAMPLE
Mr Client currently earns £100,000 a year and he contributes £25,000 annually into his pension pot. He has moved up the ladder of Scottish Income Tax bands and his tax rate is now 45 per cent. For his £25,000 pension investment he will pay £20,000 net as the UK Government contributes 20 per cent tax relief of £5,000. But as a 45 per cent taxpayer, Mr Client can also claim back a further £6,250 from HMRC.In short, his annual pension investment of £25,000 has only cost him £13,750. The higher rate tax relief of £6,250 could be an easy target when you consider the impact the removal would have on the size of the £22bn black hole.
OTHER POSSIBLE PENSION TARGETS
Like most run ups to a Budget no-one really knows what taxes will be increased. But this year, in the absence of any changes to Income Tax, VAT and NI, identifying possible targets gets a bit easier.
The Chancellor could reduce or limit the amount of tax-free cash that you can currently take from your pension fund (up to 25 per cent at present), or restrict your ability to transfer the fund tax efficiently to your family on your death. But these seem more complicated to implement in the short term than the simple reduction to the tax relief on contributions for the highest earners.
SO, WHAT CAN YOU DO?
The removal of higher-rate tax relief on pension contributions is an easy route to a windfall Treasury bonus for the Chancellor. Catch it while you can – my advice is to call your financial planner today.
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