What does a £22bn black hole mean for tax and pensions?

This article was first published on 6 September.

The Chancellor of the Exchequer Rachel Reeves made a statement to the House of Commons on 29 July 2024 after a spending audit uncovered a £22 billion black hole in the public finances for 2024/25.

Prime Minister Keir Starmer announced in his speech on 25 August 2024 that his recently appointed government had inherited a “£22 billion black hole”, forcing Labour to ask us all to “accept short-term pain for long-term good”.

Here we look at what has already been announced and what could be coming up in the Autumn Budget.

Cuts announced so far

To address the “overspend” the Chancellor made some major announcements, including:

spending cuts of £5.5billion this year, rising to £8.1billion next year;
scrapping Winter Fuel Payments for around 10 million pensioners who are not on means-tested benefits;
VAT at 20% will be levied on private school fees from 1 January 2025;
non-domiciled tax status will be replaced with a new residence-based regime from April 2025; and
the windfall tax on profits from energy and gas companies will rise by 3% from November 2024.

The Chancellor made it clear that these by no means cover the whole shortfall and warned of further tough decisions on tax and spending at the Autumn Budget on 30 October 2024. As ever, what was not mentioned by the Labour party in their election manifesto can be as important as what was mentioned in their content.

How could more revenue be raised?

The Chancellor has already made a commitment not to increase ‘‘taxes on working people’’ at the Autumn Budget, adding, “That means we will not increase National Insurance, the basic, higher or additional rates of Income Tax or VAT.”

There are a number of possible revenue-raising measures that the Chancellor could consider, including Inheritance Tax, Capital Gains Tax and Pensions.

This update is designed to highlight such areas that are thought most likely to be targeted in the forthcoming Budget.

Capital Gains Tax (CGT)

This is widely predicted to be the first area of focus for the government if it decides to match CGT rates to Income Tax rates (currently at half that of income tax rates at 10%/20%) and has the potential to raise an extra £8billion for the public finances.

In addition, the government could also decide to remove CGT rebasing on death, potentially resulting in double taxation with Inheritance Tax.

Inheritance Tax (IHT)

With £7.5billion of IHT raised in 2023, this relatively low figure could be raised if the government decides to impose an immediate tax charge on gifts of a certain size, or if it decides to introduce a lifetime transfer limit to cap the amount of wealth passed down free of tax.

Wealth Tax

This has often been commented on, but no real detail has been provided on how this would work. In general, it is unpopular and has proven to be difficult to implement in several countries, leading it in many cases to be abandoned.

Pension tax relief

Pension contributions are one of the most tax-efficient methods of investing, especially for higher earners. The level of tax relief allowed for higher earners on contributions made into pensions could come under further scrutiny by the government. At the time of writing, pension contributions generally receive full tax relief. However, there is talk of restricting this relief to basic rate.

The net cost of pension tax relief to the Treasury was £48.3billion for 2021/22.

The government could look at introducing a flat rate of 30% tax relief, which The Institute for Fiscal Studies (IFS) estimates would generate £2.7billion to £3billion. Equalising at 30% might boost pension savings for basic rate taxpayers, but as many will move into higher tax bands due to frozen Income Tax thresholds, it could undermine tax incentives. However, this could be a risky move as proven by many studies which identify a widespread lack of adequate preparation for retirement.

Restricting tax relief could also have an impact on those in the public sector (e.g. doctors), as they could find they have more tax to pay as a result of the uplift in their pensions each year.

The government could also consider scrapping higher and additional rate pension tax relief and equalising it at 20%.

If pension tax relief measures undergo any changes, savers may need to increase contributions or adjust their retirement plans, potentially working for longer.

This is a particularly good time to consider alternative tax-efficient savings vehicles, such as ISAs. For those willing to take on more risk, Enterprise Investment Schemes (EIS), Seed Enterprise Investment Schemes (SEIS), and Venture Capital Trusts (VCTs) are also worth considering. However, the tax benefits on these arrangements may also be under scrutiny in the forthcoming Budget.

Annual Allowance

The pensions Annual Allowance for most savers was increased from £40,000 to £60,000 alongside the removal of the Lifetime Allowance at Jeremy Hunt’s March 2023 Budget. Reducing the Annual Allowance back to or below £40,000 could be an option, restricting tax relief for those contributing higher amounts. However, without exemptions for the public sector, this could lead to early retirements in professions like the NHS and civil service, a problem that Jeremy Hunt’s Budget had sought to address. The Office for Budget Responsibility estimated that abolishing the Lifetime Allowance (LTA) and raising the Annual Allowance (AA) cost £1.2billion annually, raising questions about the extent of any potential savings.

Tax-free lump sum

The tax-free lump sum is currently capped at £268,275. Could the Chancellor announce further restrictions? This is a popular benefit – many retirees use the lump sum to pay off mortgages or for other large expenditure in retirement. Moving the goalposts here would also be unpopular and a disincentive to pension saving.

Death benefits on defined contribution (DC) plans

Some think tanks have proposed bringing DC pension pots in to scope for Inheritance Tax by taxing beneficiaries who draw on pots inherited before age 75 (this is currently tax free).

Pre-Budget planning: how to prepare

Below is a short list of items to consider when planning but, as always, it is important to take financial advice to ensure this is the right course of action for you. If you are already in contact with your PWM adviser, you will have such matters under consideration. If not and you wish to review any of these areas, please contact your PWM adviser directly.

Capital Gains Tax

Use your CGT allowance and carried-forward losses by selling down assets with gains.
Consider “clearing the decks” and selling down all gains, paying 10% and 20% before the rates potentially rise.
This also applies to Buy-To-Let properties, where the applicable tax or interest rates are 18% and/or 24%.
Consider reinvesting the proceeds into more tax-efficient investments, providing you with greater control over future taxation and reporting.

Inheritance Tax

Consider gifting assets now pre-Budget, starting the “seven-year clock”.
Utilise all available allowances where possible.
Consider regular gifting from excess income.

Pension Contributions

Maximise any available contributions pre-Budget, including Carry Forward where available.
Consider initiating a salary sacrifice arrangement, starting before the Budget.

Retrospective Legislation

While retrospective legislation is uncommon, it is still a possibility. However, while it is important to bear this in mind, it should not deter you from now taking proactive steps in your financial planning.