17 November 2017

Why pension tax relief is in the Chancellor's sights, five things he might cut - and one he won't

8 min read

Steve Webb
Royal London



New analysis by Royal London has highlighted the fiscal pressures on the Chancellor due to a combination of spending pressures, revenue shortfalls and an inability to raise politically sensitive rates of tax, NICs and VAT.

This suggests that Pension Tax Relief will again be under the microscope after six separate cuts in the last six years. The analysis goes through five different areas where cuts could be made – the annual allowance, the tapered annual allowance, the lifetime allowance, various technical detailed ‘corners’ of the system, and the NICs treatment of employer contributions – and estimates the likelihood of each. It then discusses one change that Royal London does not expect to see – a cut in the amount of ‘tax-free cash’ which savers can access.

Commenting on the analysis, Steve Webb said:

"Since 2010, the Treasury has ‘form’ on raiding pension tax relief on an almost annual basis. With pressure to spend more, especially on young people, and with revenue shortfalls from a stuttering economy, a politically weakened Chancellor is likely to turn again to tax relief as a source of less politically challenging revenue raising. The annual allowance remains the most likely source of cuts, especially with the increase in the ISA limit, but other aspects of the system may not escape scrutiny. Pension savers must long for the day when pension tax relief is a stable regime which supports long-term planning, rather than an easy source of ready cash for cash-strapped Chancellors."

Royal London’s full analysis follows:

Why pension tax relief is in the Chancellor’s sights – and where the cuts could come

Ahead of this year’s Budget, the Chancellor faces a ‘triple whammy’ of revenue shortfalls, additional spending pressures and political weakness which makes raising headline direct tax rates almost impossible. As a result he is likely to look again to find savings in areas of public spending which are complex and little-understood and which cost large amounts of money, which makes pension tax relief a prime target. In this note we look at why the Chancellor is feeling the squeeze and how pension tax relief could see another cut in the forthcoming Budget.

Fiscal pressures on the Chancellor


Latest productivity estimates from the Office for National Statistics suggest that UK productivity growth has been weaker than expected. This is likely to feed through into reduced tax revenue forecasts for the coming year, wiping out a large part of the Chancellor’s room for manoeuvre if he plans to stick to his fiscal targets.
In addition, the Chancellor has a Budget hole caused by two significant revenue-raising measures which were announced and banked but where the policy has since been reversed. These are:

  • The 1% rise in the National Insurance rate paid by the self-employed in 2018 and again in 2019; this was due to raise around half a billion pounds per year; the policy was quickly dropped after the 2017 Budget;
  • The planned rise in fees for ‘probate’, especially for larger estates; the measure was expected to raise around a third of a billion pounds a year but has now been dropped;


The Chancellor will be looking to find additional revenue to meet spending pressures in several key areas:

  • Public sector pay, where seven years of ‘freezes and squeezes’ are finally starting to be lifted;
  • The NHS, where the growing demands of an ageing population mean demand for services continues to outstrip funding growth;
  • Social care, where local authorities have repeatedly squeezed access to support and the Care Quality Commission now estimates over 1 million people now have ‘unmet’ care needs;
  • Meeting the £1 billion cost of the ‘Confidence & Supply’ deal with the Democratic Unionists;
  • Finding additional funding for younger voters and those looking to buy a first home; he will also have to meet the cost of announcements already made on tuition fees;
  • Dealing with concerns over the implementation of Universal Credit; when the additional seven days ‘waiting period’ for UC claimants was announced in the 2013 Spending Round, the saving was estimated to be around £250m per year;

Political Weakness

By far the simplest way of raising revenue would be to increase the main rate of a big tax such as income tax, national insurance contributions (NICs) or VAT; following the March 2017 row over NICs for the self-employed it seems unlikely that the Chancellor will return to this area so soon, and raising headline rates of income tax or VAT so soon after a General Election would be extremely challenging; smaller taxes such as Insurance Premium Tax could rise again, and there is speculation that there will be a new tax on diesel vehicles, all of which suggests that it will not be the high profile areas of the tax system where the Chancellor looks for additional revenue.

Pension Tax Relief – what might change?

The latest HMRC figures suggest that the cost of pension tax relief rose by around £3 billion in the last year for which figures are available. In addition, the cost of not charging National Insurance Contributions on employer pension contributions rose by a further £2 billion. Since 2010, successive Chancellors have cut the various limits for pension tax relief on an almost annual basis, and the present Chancellor is likely to have taken a very detailed look at how much more can be saved on this major item of public spending.

The most likely areas to feel the squeeze are:

The Annual Allowance

Currently, most earners can contribute £40,000 per year into a pension and benefit from tax relief. With contribution limits on ISAs having been raised substantially in recent years to £20,000, the Chancellor will feel he can cut the annual allowance with very limited political fallout. The most recent cut in the general level of the annual allowance was in 2014/15 (down from £50,000) and that change (combined with a linked reduction in the lifetime allowance – see below) is estimated to raise around £1.1 billion in 2017/18.

One little-noticed reason why Annual Allowance reductions are now more likely is the major reform of public sector pensions. In the past, public sector pensions were based around an individual’s final salary, which meant that someone who was promoted (eg from a deputy head to a headteacher) saw a big surge in their pension rights as their whole service became valued at their new enhanced salary. A generous annual allowance was needed to avoid such individuals facing a big tax bill when they were promoted. However, public service pensions are now based on a ‘career average’ basis which means that promotions do not create the same surge in pension rights. The Government may conclude that they can now justify a much lower Annual Allowance.

Possible changes: One or more cuts to the annual allowance, perhaps to £35,000 and then to £30,000

Likelihood: 8/10

The Annual Allowance for high earners (AKA the ‘tapered annual Allowance’)

From 2016/17 the Government made a further reduction in the Annual Allowance, this time focused on high earners. The rules are complex, but the change mainly applies to those with total taxable income, including the value of any employer pension contributions, above £150,000 per year. For every £1 of income above this threshold, the Annual Allowance is ‘tapered’ down by 50p until it reaches a floor of £10,000 at incomes of £210,000 or more. When fully implemented (that is, when the ability to carry forward unused annual allowances from earlier years is exhausted) this measure is expected to raise over £1 billion per year.

It seems likely that the Chancellor will be looking to revisit this measure to see if extra revenue can be found. This could be by reducing the £150,000 threshold and/or increasing the taper rate. From the Chancellor’s point of view, the attraction is that this is a complex area which will affect relatively few voters but which could raise significant amounts.

Possible changes: A cut in the £150,000 threshold to £125,000.

Likelihood: 8/10

The ‘Lifetime Allowance’

As well as an annual limit on tax-privileged pension contributions, there is also a lifetime limit on the size of pension pot which can be built up whilst benefiting from pension tax relief. In 2010 the limit stood at £1.8 million, but this was cut to £1.5 million in 2012, £1.25 million in 2014 and £1 million in 2016. Each of these changes was accompanied by a complex system of transitional arrangements. As this is an area where Chancellors have repeatedly sought revenue, there must be a chance that we will see further cuts to the LTA.

Possible changes: A cut in the Lifetime Allowance to £900,000

Likelihood: 6/10

Detailed rule changes

One attraction to the Chancellor of changing the detailed rules around pension tax relief is that the system is not widely understood by the general public and the political impact of changes is therefore much reduced. There are some particular areas where savings might be found:

Possible changes:

- Reduction in the ability to ‘carry forward’ unused allowance from earlier years: at present, individuals can carry forward up to three years’ worth of unused annual allowances; this means that whenever there is a change to the annual allowance the revenue takes time to come through as people simply carry forward unused allowances from earlier years to make up the shortfall;

Likelihood 5/10

- Further reduction in the Money Purchase Annual Allowance: once individuals start to take taxable cash from their pension pot, the amount they can put back in to pension saving is reduced; this is to discourage ‘recycling’ where individuals put money into a pension to benefit from tax relief and a tax free lump sum on withdrawal before putting the money back in again; the limit was introduced at £10,000 per year but the Chancellor used his first Autumn Statement to cut this limit to £4,000 from April 2017 ; the Election interrupted the necessary legislation, which is only now being put into effect; a further cut is possible, though the original cut only raised £70m per year, which is a relatively modest sum in terms of tax revenue; a further cut cannot however be ruled out;

Likelihood 3/10;

Apply National Insurance to employer pension contributions

When an employer pays a wage to an employee, the firm is liable for a NICs rate of 13.8%, but if that money is paid into a pension there is no National Insurance to be paid. HMRC estimates that that the cost to the Exchequer of not levying employer NICs on employer pension contributions was £15.7 billion in 2015/16, an increase of £2 billion on a year earlier.

Whilst charging full NICs on employer contributions would be a huge change, a ‘special’ new rate could be introduced and could be a significant revenue raiser.

Possible changes: A new 1% rate of NICs on employer pension contributions, raising around £1 billion per year

Likelihood: 5/10

And finally…something not likely to change

At Budget times there is always speculation about the future of the ‘tax free lump sum’ – the 25% of most pension pots which can be taken at retirement without any tax. However, a politically weak Chancellor would find it incredibly difficult to remove this benefit which is one of the few elements of the pension tax relief system which is reasonably widely understood and valued. He could, in principle, announce that *new* money going into pensions would no longer attract a tax free lump sum, but this would raise little revenue in the short-term and would stoke up alarm that existing tax-free lump sums could be under threat. Even if action on tax-free cash was taken in the Budget it is hard to believe any significant change would command a majority in the House of Commons once the impact on savers became apparent.

- ENDS -

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Royal London Press Office

About Royal London:

Royal London is the largest mutual life, pensions and investment company in the UK, with funds under management of £117 billion, 8.8 million policies in force and 3,745 employees. Figures quoted are as at 30 June 2018.