As is often the case, as soon as a budget date is confirmed a flood of speculation swamps the finance sector as it tries to predict the Treasury’s plans.
This marks Rishi Sunak’s third budget since he became chancellor at the beginning of 2020, a period marked by considerable tumult and sky-high government spending.
Speculation has been rife, but there seems to be a consensus among industry players on three possible changes: inheritance tax (IHT), pensions, and CGT.
IHT
International Adviser recently reported that the Institute for Fiscal Studies suggested the chancellor stop allowing defined contribution (DC) pension schemes to be exempt from death taxes.
This is because DC pots do not form part of a person’s estate and, as such, are not liable to IHT.
The institute described the carve out as “indefensibly generous”, as people have been using DC pensions as a way to maximise how much money they would be able to pass on to their children and grandchildren.
But how likely is such an overhaul to happen?
Tom Selby, head of retirement policy at AJ Bell, said: “If the chancellor wants to raise money from wealthier people, he could turn his attention to taxes paid on death.
“Pensions can currently be passed on tax-free on death if the person dies before age 75, and at your recipient’s marginal rate of income tax if you die after age 75.
“Applying a tax to inherited pensions would clearly raise much-needed cash for the Treasury, although how much would depend on whether a protection regime was introduced for existing funds or not.
“If it wasn’t, those who have paid into pension on the basis of the death benefits on offer would understandably feel angry at the rug being pulled from under them.
“Inheritance tax is the other lever the Treasury could pull here, either by reducing the headline rate or lowering the amount that can be inherited tax-free.
“Both measures would inevitably lead to ‘death tax’ headlines, however – not something politicians hoping for re-election would generally welcome.”
CGT
A change to the way capital gains tax is applied to gains has been rumoured for the last year and a half, after the Treasury asked the Office for Tax Simplification (OTS) to review the current system in July 2020.
It ended up recommending aligning CGT rates with income tax.
While this failed to materialise in the last spring budget and autumn spending review, has the time now come?
Laura Suter, head of personal finance at AJ Bell, said: “This could be the big change we see announced on budget day, with increasing ‘wealth taxes’ being a popular move to help restore the country’s finances after the pandemic.
“Capital gains tax generated £10.6bn ($14.5bn, €12.5bn) last year, and this is rising as property and investment prices climb.
“The speculation is that the current CGT rates of 10% and 20% – or 18% and 28% for property – will be scrapped and instead everyone will pay income tax rates on their gains. This move was mooted by the OTS last year in its review.
“The stipulation from the OTS was that investors should get some sort of inflationary relief, so they are only taxed on above-inflation gains. Clearly, any relief would reduce the tax-take for the government, so that may be quietly ignored in any final rules.
“In a less radical move, the government could cut the tax-free allowance from its current £12,300. The allowance has already been frozen until 2026, but now the manifesto promise of no tax increases has already been cast aside, there’s no barrier for Rishi Sunak to cut the allowance.
“Chopping it in half, to £6,000, would generate £480m, while cutting it to £2,500 would give an £835m boost to government coffers, according to OTS predictions.”
Pensions
How could speculation around pensions not feature in a pre-budget wish list?
The government has already broken its manifesto pledge to leave the triple lock untouched and moved to a double lock system for the 2022-23 financial year.
Who is to say that such a move won’t open a window of opportunity for further reform?
According to industry players, there are two ways pensions could be impacted in the budget: a change to tax allowances, and a limitation to the tax-free lumpsum people are able to withdraw from their pots under pension freedoms.
Tax relief
Steven Cameron, pensions director at Aegon said: “With so many pension priorities and changes being advanced, the autumn budget is not the time for a radical reform of pensions tax relief. A move to a flat rate of pensions tax relief, rather than the current system where relief is based on the rate of income tax paid, would be far from simple to implement.
“It would be particularly challenging for defined benefit (DB) schemes and could mean medium to high earners including doctors in public sector schemes face big tax bills. It would only benefit the Exchequer if the cuts in incentives for higher rate taxpayers were greater in total than any increased incentive for basic rate taxpayers. There are no quick wins here for the chancellor, change would be very complex and any savings for the Exchequer from less tax relief would take significant time to realise.
“In his spring budget, the chancellor froze the lifetime allowance, the maximum an individual can save in their pension on a tax favoured basis. Over the five-year freeze, growing numbers of medium earners as well as higher paid will hit the maximum they can save in a pension with tax breaks. This reduces the justification for making other cuts in incentives for higher rate taxpayers.
“Currently, the government is pushing those running DC pension schemes to make significant changes to where they are investing members’ funds to address climate change and to invest more in infrastructure and start-up companies to turbo-charge the economy. Reducing tax incentives for many pension savers risks sending out mixed messages.”
But AJ Bell’s Selby believes that, if the Treasury was to take such a route, the annual allowance would probably be the “simplest lever to pull”.
“The annual allowance is currently set at £40,000, while savers can also ‘carry forward’ up to three years of unused allowances.
“Lowering this to £30,000 or even £20,000 – in line with the Isa allowance – would raise revenue for the Exchequer while only affecting those who make very large pension contributions.
“The lifetime allowance could also potentially be reduced, although given it was frozen for the rest of this parliament at just over £1m at the last budget this seems highly unlikely.”
Tax-free cash
Another highly rumoured change is the one that could impact retirees’ ability to take money from their pots tax free.
Becky O’Connor, head of pensions and savings at Interactive Investor, believes that a decision along these lines would be “deeply unpopular” with “widely felt” effects, but it could be “justified from the point of view of dissuading people from taking out too much, too soon from their pensions”.
Selby agrees about the unpopularity of the move, but also warned it could create an additional layer of complexity on top of an already difficult pension system.
“While the Treasury has seriously explored radical tax relief reform, it is telling that tax-free cash has never been looked at in the same way.
“This is likely in part because any move to cap or abolish tax-free cash altogether would be extremely unpopular, and in part because it would almost certainly involve creating a protection regime, so pension contributions already made continue to benefit from their existing tax-free cash entitlement.
“This would deliver an unwelcome double for the chancellor of unpopularity and complexity. What’s more, any savings to the Exchequer would potentially take years to materialise.”
Tax breaks on financial advice
Advisory firm LCP took matters in its own hands and filed a pre-budget submission to the Treasury asking for greater tax incentives for those receiving financial advice.
More specifically, it suggested an increase to the current cap of £500 on the Pensions Advice Allowance (PAA), as well as on employer-funded advice.
Clive Harrison, partner at LCP, said: “The chancellor should use his budget to improve the tax breaks for financial advice, which are simply not working as things stand. The current allowances are too low and too restrictive, and even when members know about them and want to use them, they may find that their pension provider refuses.
“There is no doubt that good financial advice can add real value, and far too few people are taking up advice. Reducing the cost of advice through tax breaks is a step in the right direction, but much more needs to be done to make these schemes more effective”.
Change?
But others within the industry do not think any such reforms are going to happen.
Neil Jones, head of wealth planning at The Private Investment Office, said that income tax, CGT and IHT have been very profitable for the Treasury as “this is the seventh consecutive month that 12-monthly receipts for all three have increased and produced record income”.
For instance, IHT receipts first broke the £3bn mark in August 2012, £4bn in July 2015, £5bn in May 2017 and £6bn in August 2021.
CGT receipts followed a similar path and are now almost double that of inheritance tax with the last 12 month yielding nearly £11.5bn, Jones said.
“Some taxes go through reform or significant changes once or twice in a lifetime.
“Inheritance tax has not seen a significant change since it was introduced in 1984 and we know that capital gains tax does not meet the policy objective it was originally designed for; taxing income that is not caught by the income tax rules.”
So, Jones asks, why change something that is “producing an increasing revenue?”
