3 ways Labor will tax your pensions in the budget and how to fight it | Personal Finance | Finances

Reeves has already shown she is willing to make tough decisions by controversially throwing the axe at the winter fuel surcharge for 10 million pensioners. Now he looks set to do even more damage to the nation's wallets by staging a series of potential tax raids on October 30.

It is said that its goals are our pensions, capital gains and inheritances, and perhaps many other things.

Some people in the UK don't hang around and report that millionaires and foreigners are hopping on their private jets and taking their money with them.

This isn't an option for most of us, but there are still things people can do to protect their assets from the government's fiscal onslaught.

But tread carefully. Making one-off financial decisions based on speculation before the budget is adopted, which may turn out to be unfounded, is risky.

Hasty decisions can cost you more than you save in taxes.

So over the next four days, we'll look at what taxpayers can do and what they shouldn't do. Today we look at what Labor has in store for pensions and how to fight it.

First the good news.

There has been intense speculation that the Chancellor will cut tax relief on pension contributions for higher earners. Instead of getting a 40% or 45% tax break, she wanted to lower it to 25% or 30% for everyone.

The plan appears to have been scrapped under pressure from public sector unions, which warned it would hit not only the private sector but also doctors, nurses and teachers.

Alice Haine, personal finance analyst at funds platform Bestinvest by Evelyn Partners, said the threat to pension tax relief had caused a “dramatic” increase in the number of people pumping money into pensions to take advantage of the current higher rates, adding: “Now the pressure seems to be less off.”

But Nicholas Nesbitt, a partner at tax consultants Forvis Mazars, said Reeves currently has two clear retirement goals: “Limiting the 25% tax-free lump sum and potentially imposing a new death tax.”

There is a third one worth knowing about.

1. Limitation on the amount of tax-free pension lump sum. Currently, pensioners can take 25% of their total pot tax-free from the age of 55, often called a tax-free lump sum. This is an extremely popular benefit.

Many people plan their retirement around this, for example by using capital to clean up their finances, mortgage, finance the trip of a lifetime or prepare their home for later life. The tax-free allowance limit is currently £268,275 and this only applies to those on the highest pensions, but the Chancellor could reduce this to £100,000.

This will affect anyone whose pension is over £400,000, said Helen Morrissey, director of pensions research at Hargreaves Lansdown.

That may seem like a lot, but it's only enough to buy a 65-year-old an inflation-linked annuity paying just over £20,000 a year, Morrissey said: “It's definitely not enough to fund a lavish lifestyle.”

Myron Jobson, of Interactive Investor, said lower capitalization would derail plans, adding: “Those who have used amounts above £100,000 to pay off their mortgages and other debts would either have to find cash elsewhere or struggle with more debt.

He said the tax-free lump sum is one of the best-loved pension benefits and Reeves risks undermining confidence in pensions, “and that's the last thing we need because people aren't saving enough.”

What can you do? People over 55 don't hang around. Many people are racing to claim their tax-free cash, overwhelming pension company helplines.

However, there are dangers. Although money in retirement is tax-free, if you make withdrawals and simply put it in a standard savings account, the money will likely grow more slowly.

Future returns may also be taxable, although tax-free Isas can be helpful here.

There is one more disadvantage. Once you start withdrawing your pension, the amount you can pay into your pension will drop to just £10,000 under a technical allowance known as the Money Purchase Annual Allowance (MPAA).

This can make it more difficult to build up your pension in the final years before retirement.

My Pension Expert policy director Lily Megson urged caution. “Nothing has been confirmed and it is unlikely that any changes to the budget will come into force before the next financial year on April 6, 2025, which allows enough time for planning. Wait until we know more specific details.

However, those who have decided that now is the right time to take some tax-free cash may want to act ahead of the budget just in case.

2. Cutting your annual pension. Every year, savers can contribute up to 100% of their salary to the pension and benefit from tax relief on contributions. This limit is 60,000 pounds and it is the so-called annual pension allowance. This drops to £10,000 for those who make withdrawals and trigger the MPAA.

Former Tory chancellor Jeremy Hunt increased the annual allowance from £40,000 in his Budget in March 2023. Reversing this is simple and would be politically appropriate for Labor as it would hit higher earners.

Paul Gooch, director of Walker Crips Financial Planning, warned: “The annual allowance may be reduced but no specific details have been released as of yet.”

What can you do? Reeves can't actually cut your annual benefit amount midway through the tax year. Any changes are likely to come into force in the 2025/26 tax year.

But it's still worth making the most of today's annual allowance if you can, said James Norton, director of pensions and investments at Vanguard Europe. He added: “If you haven't fully used up your annual allowance in the previous three tax years and don't have access to your pension, you may be able to carry over the unused amount and contribute over £60,000.”

3. Taxation of pensions after death. People who die with unused pension savings can pass it on to their loved ones free of 40% Inheritance Tax (IHT).

This applies to defined contribution pensions, where the money is invested in the stock market, rather than defined benefit pensions, which are 'final salary'. Many wealthier people use savings and investments in the early years of retirement that may be subject to IHT, including ISAs. They reserve their pension for last, hoping to pass on any unused pot IHT-free.

The Institute for Fiscal Studies estimates that taxing pensions on death could generate £2 billion a year, and BDO tax partner Jon Hickman believes this is likely, saying: “It would be less politically difficult than other options.”

Nicholas Nesbitt of Forvis Mazars agreed, saying that exempting pensions from income tax “has long seemed an anomaly” and added: “Given the wealth accumulated in pensions, we expect a Labor government to start taxing pensions in case of death.”

What can you do? Those who have kept pensions in reserve will be furious if Labor changes the goalposts.

However, in many cases pensions are already taxable upon death. If you die at age 75, recipients must pay income tax on the inherited pot at the marginal rate. Some may have paid as much as 40% or 45%.

– said Becky O'Connor, director of public affairs at PensionBee. “Making pensions subject to IHT and income tax would make them less attractive and potentially discourage people from saving on them.”

One option is to reduce your overall exposure to IHT by giving gifts to loved ones or setting up a trust.

Tax planning is complicated and time is tight. It may be too late to seek financial advice, but it's still worth a try. But tread carefully. For now, we can't say for sure what Reeves will do. By far the most likely option, however, seems to be tax-free cash raids and a tax on pensions.