"None of the 'wealth taxes' - capital gains tax, inheritance tax and the tax benefits around pensions - that remain on the table for the Chancellor are huge revenue raisers on their own, at least not without major reform."
- Gary Smith, financial planning partner at Evelyn Partners
Chancellor of the Exchequer Rachel Reeves said in a speech yesterday that a spending audit had revealed a £22 billion black hole in the public finances for 2024/25, setting out some spending cuts to immediately narrow the ‘overspend gap’ with in-year savings.
But as these do not cover the whole shortfall, she warned that there would be further tough decisions on tax and spending at an Autumn Budget set for 30th October, while reiterating pledges made in the manifesto.
Reeves repeated her commitment not to increase ‘taxes on working people’ at the Budget: "That means we will not increase national insurance, the basic, higher or additional rates of income tax or VAT."
Tax and pension experts gave their thoughts on the speech:
Julian Jessop, economics fellow at the Institute of Economic Affairs, commented: "Rachel Reeves’ statement on the state of the public finances was good in parts. The estimates for the size of the ‘black hole’ may be suspect, but the increased scrutiny of in-year spending is welcome. The new Chancellor also appears willing to take tough decisions to save taxpayers’ money, such as ending winter fuel payments for better-off pensioners.
"However, taking the figures at face value, the immediate savings identified will only reduce this year’s shortfall from £21.9 billion to £16.4 billion. This suggests that substantial tax rises in the Autumn Budget will still be needed to close the gap.
"Moreover, the biggest single item is the bill for above-inflation pay rises in the public sector, only partially funded by efficiency savings. The Chancellor has also decided to double down on the existing fiscal rules, which are arbitrary and hold back the economy.
"The result is likely to be further cuts in infrastructure spending and large increases in the taxes on investment, which is not a good look for a Government that says it is prioritising growth."
Gary Smith, financial planning partner at Evelyn Partners, said: "Whether or not there has been sleight of hand from either side in this row over the public finances and fiscal intentions, we should probably expect the Chancellor to announce tax rises in some form in October, even if this was not explicitly broached.
"Some think the Chancellor will “get it all over with” with tax rises, which can at the moment be blamed on the fiscal inheritance and be at least partially forgotten by the time of the next election. Others think she will go softly and test the water with some moderate measures.
"The issue is that none of the 'wealth taxes' - capital gains tax, inheritance tax and the tax benefits around pensions - that remain on the table for the Chancellor are huge revenue raisers on their own, at least not without major reform.
"Capital gains tax has featured in a lot of speculation but it’s unlikely that a change to the rate would be announced in October, to come in next April, as that would spark an exit from assets in the intervening periods as investors rushed to bring forward disposals to take advantage of the current rate.
"Also any major cuts to pension tax relief could affect the public sector defined benefit pensions schemes that the new Government will be keen to protect."
Capital Gains Tax and Inheritance tax
Both taxes remain on the table for reform in the October Budget, but industry experts remained undecided whether rates would be changed this year.
IHT is usually paid at 40% on the value of your estate over the £325,000 allowance. There’s an additional allowance of up to £175,000 if you pass on your family home to children or grandchildren. If you’re married or in a civil partnership, you can combine your allowances and transfer assets between each other free of the tax.
Rob Morgan, chief investment analyst at Charles Stanley, said: "The Labour manifesto was silent in the matter of IHT, leaving the door wide open to reform. Frozen allowances and higher house prices are pushing more estates into paying inheritance tax and receipts are at a record high, but there is potential for the screw to tighten further. It’s possible that rule changes result in a higher tax rate or the reduction of reliefs including the ‘nil rate band’.
"At first glance there appears to be little scope to ratchet up tax on capital gains with the CGT allowance halved to just £3,000 for the current 2024/25 tax year. Indeed, Labour previously said it has “no plans” to change CGT rates, which depend on the income tax rate you pay and whether the asset is residential property. However, with its full audit of the nation’s finances now complete those plans might well have changed.
"Any moves to align CGT rates to those of income tax, as has been speculated, could catch out some investors. It’s a call to action to use all available tax shelters such as ISAs and pensions to the greatest extent possible. Investors with larger portfolios outside these wrappers may face a triple whammy of a low capital gains allowance, a higher tax rate and no account of inflation through how long an asset had been held – as was the case with the taper relief and indexation of days gone by.
"There could also be more targeted ways to increase taxes on capital such as reforming the reset of capital gains on transfer of assets to a spouse on death or reducing CGT business reliefs. Again, it’s a case of ‘watch this space’, but entrepreneurs and business owners looking to dispose of stakes or assets should be on high alert to any changes that might occur."
Gary Smith, financial planning partner at Evelyn Partners, added: "With the baby boomer generation now hitting their sixties and seventies, the temptation for successive Governments will be to tap into it by taxing the “great wealth transfer” to plug gaps in the public finances. The first Budget from a Labour Chancellor in 14 and a half years will be closely watched for any review into IHT reliefs.
"The sole mention of inheritance in Labour’s manifesto regarded the use of offshore trusts for non-doms – but senior Labour figures have previously made it clear they think some inheritance tax exemptions and allowances are too generous. Apart from the IHT-exempt status of defined contribution (or money purchase) pension pots, the other major talking point on IHT is around business and agricultural property reliefs.
"There are legitimate reasons behind these reliefs, which help family and rural businesses to remain intact and going concerns on the death of owner, thereby savings jobs and assets of community value. Even criticism that focuses on the use of business relief to protect AIM shares holdings must take into account that it's there to encourage private investment in small British firms – something that is sadly in short supply in the UK economy at the moment.
"Within Labour there are advocates for raising capital gains tax, and even aligning it with income tax rates, but the leadership have said there are no plans to do so. Any move in that direction would probably be kept under wraps, with little notice given before new rates came into force, because the prospect of higher CGT rates will see many investors dispose of assets in mitigation.
"So, if this is on the Chancellor’s agenda, could it be one for April rather than October?"
Pensions Tax Relief
The net cost of pension tax relief to the Treasury was £48.3billion for 2021/22. Estimates from the Institute for Fiscal Studies suggest imposing a flat rate of 30% for everyone could generate £2.7-£3.0billion annually.
Steven Cameron, pensions director at Aegon, commented: “Following Chancellor Rachel Reeves setting out the scale of the gap in UK’s finances, Treasury civil servants have no doubt been dusting off their analysis of how reforming pensions tax relief might increase tax receipts.
“One of the plans to move to a flat rate of pensions tax relief somewhere between the basic and higher rates of income tax, which could be argued as fair, but also has its flaws.
“A flat rate of relief of say 30% would be good news for basic rate taxpayers. Currently, every personal contribution of £80 they make receives a £20 tax relief top-up. Under a 30% rate of relief, this would be increased to £34.28 – an extra £14.28 - which over time and with compound investment growth will provide a more generous pot at retirement.
“But this would be at the expense of higher and additional rate taxpayers who would get a less generous top-up. A higher rate taxpayer paying in £80 would also see this topped up by £34.28, less generous than the current top-up of £53.33.
“Higher rate taxpayers could face a double whammy as it’s likely they’d also be required to pay income tax on employer pension contributions. This would be needed to stop employees ‘doing a deal’ with their employer to sacrifice some of their salary in return for a higher employer pension contribution. This could mean employees paying tax of 10% of employer contributions, a further £10 hit for every £100 paid by their employer.
“In some schemes, employers pay very substantial contributions. In some public sector defined benefit pensions, employer contributions can be worth 20% or more of pay. Here, an individual earning £60,000 might be benefitting from an employer contribution of £12,000 a year and could be landed with a tax bill of £1,200. We’ve already seen the pensions tax system discouraging higher paid professionals in the NHS from remaining in work, and this could have a similar effect.
“It’s right that a new Chancellor explores all options around taxation and tax reliefs. When it comes to pensions tax relief, it’s a careful balancing act between ‘fair or flawed’ or between ‘friend and foe'."
Gary Smith, financial planning partner at Evelyn Partners, stated: "Rachel Reeves would not be the first Chancellor to cast an eye over the cost to the Treasury of pension tax relief.
"The nuclear option would be to scrap higher and additional rate pension tax relief and equalise down to the basic rate of 20% for everyone but this does seem very unlikely. Even equalising it at 30% would be a huge project and quite controversial, but at least it can be sold as benefitting lower earners as basic-rate taxpayers would receive a bigger uplift to their contributions.
"It would mean many savers are 'double-taxed' on both contributions and income when they access their savings, it would be problematic for public sector defined benefit schemes and would also involve taking a spanner to private sector net pay and salary sacrifice schemes.
"A flat rate of 30% might give a modest boost to the pension savings of basic rate taxpayers but let’s not forget that millions of today’s basic rate taxpayers are the higher and additional rate taxpayers of the future. As millions of workers are being drawn into higher tax bands by frozen income tax thresholds, such a step would remove the one remaining sweetener of this stealth tax rise.
"When study after study shows that people aren’t saving enough for their retirements, it seems a dangerous step to mess with tax incentives for doing so."
Winter Fuel Payments
In her speech yesterday, Reeves proposed to remove entitlement to Winter Fuel Payments from those not receiving certain means-tested benefits. However, pension experts have warned that this could create a ‘cliff edge’ where those just a few pounds above pension credit levels could lose up to £300. In particular, the standard rate of the new state pension is £221.20 per week whilst the standard rate of pension credit for a single person is currently £218.15 per week. This means people on the standard new state pension will be just over £3 per week over the limit and will lose all of their Winter Fuel Payment.
One consequence of the new rules is that people on low incomes will need to think twice before topping up their state pension if this might lead to them losing entitlement to a Winter Fuel Payment.
There is also a risk that the package as a whole will not save nearly as much as the budgeted £1.4bn in 2024/25 and £1.5bn in 2025/26. This is because pensioners will have much more incentive to claim Pension Credit now that it is a ‘gateway’ to Winter Fuel Payments as well as other benefits. When the free BBC TV licence for all over 75s was limited to those on pension credit this led to a surge in applications for pension credit, and a similar effect is likely in this case.
Steve Webb, partner at LCP and former pensions minister, commented: “Whilst the government has some difficult choices to make, means-testing the Winter Fuel Payment will create some unwelcome ‘cliff-edges’ in the pensions and benefits system and could save much less than expected as take-up of pension credit soars. Pensioners living purely on the new state pension will be just a few pounds above pension credit levels and may be very resentful at losing up to £300 per year, especially as their state pension will soon fall within the income tax net as well. Ministers need to be careful that greater use of means-testing in retirement does not create new complexity and unfairness, and discourage people from saving for their retirement.”
Jon Greer, head of retirement policy at Quilter, added: "It’s never been more important for pensioners on low incomes to check their eligibility for pension credit, given the news that the Winter Fuel Payment will now be contingent on you claiming the credit or other mean tested benefits.
“Unfortunately, despite frequent campaigns by the media and government many pensioners miss out on claiming pension credits. This can be down to lots of reasons but often its due to a lack of awareness or a feeling that they won’t be eligible, so they don’t bother. However, if missed, eligible pensioners miss out on a significant boost to their retirement income and also now the valuable Winter Fuel Payment.
"The importance of claiming this credit if eligible cannot be overstated. Pension credit not only guarantees a weekly income to £218.15 if you’re single or £332.95 if you have a partner - but also opens the door to a variety of other benefits. These include help with housing costs, council tax, and heating bills."
