We understand that recent media speculation around the forthcoming budget and Labour's commitment to addressing the £22 billion shortfall may have caused some concern. As your financial advisers, we want to ensure that you're informed about any potential changes while emphasising that our advice must be based on the current rules and regulations. Providing guidance based on speculation could impact other areas of your financial plan.
To provide more context, we’ve included a link to Fidelity’s insights on the possible pension changes:
Labour's Possible Pension Changes
Potential Changes to Tax-Free Lump Sums
There is concern over whether the tax-free lump sum could be capped at a lower percentage or removed entirely. This would impact private sector clients nearing retirement, as well as public sector workers such as doctors, teachers, and police officers who participate in final salary or CARE pension schemes. Labour's manifesto, which emphasises increasing workforce numbers in key sectors, suggests that drastic changes may be unpopular and could result in early retirements. Fidelity's view, based on this, is that change in this area is unlikely.
Tax-free lump sums are often used to:
Pay down or clear mortgages, reducing retirement expenses
Fund holidays or major purchases like a new car
Supplement retirement income efficiently
Establish an emergency fund
Provide gifts to family members (e.g., for house purchases or education)
Retire early due to ill health
Invest for potential growth or for inheritance tax planning purposes
The current cap on tax-free lump sums, set by the Conservative Party in 2023, is £268,275 following the removal of the lifetime allowance.
Inheritance Tax Considerations
Pensions are generally tax-efficient and often fall outside of an estate for inheritance tax purposes. Currently, if death occurs before age 75, the pension is paid to beneficiaries tax-free. After age 75, it's taxed at the beneficiaries' marginal rate. However, if the tax-free lump sum is accessed earlier than planned, it could increase the estate's value and lead to other financial considerations should inheritance tax rules change.
For example, if your pension is currently valued at £200,000, the tax-free lump sum would be £50,000. Assuming a 6% annual growth (net of charges):
In 1 year, the pension value would be £212,235, and the lump sum would be £53,059
In 3 years, the pension value would be £239,336, and the lump sum would be £59,834
In 5 years, the pension value would be £269,770, and the lump sum would be £67,435
Please note that these figures are not guaranteed and depend on the underlying performance of your investments.
Tax Relief on Contributions
There is also speculation that Labour could introduce a flat rate of tax relief on pension contributions. Currently, tax relief is based on income:
Basic rate taxpayers receive 20% relief
Higher rate taxpayers receive 40%
Additional rate taxpayers receive 45%
If a flat rate of 25% or 30% were introduced, basic rate taxpayers would benefit, encouraging savings for retirement among lower earners. Higher and additional rate taxpayers would still receive relief, albeit at a reduced level, but contributing to a pension would remain tax-efficient.
Inheritance Tax and Pensions
Pensions are often used as part of inheritance tax planning due to favorable tax treatment on death benefits. While Labour could consider changes in this area, it would be a complex decision that might encourage clients with significant pension funds to spend, rather than preserve them for inheritance planning.
Looking Ahead
At this time, we cannot predict what changes may occur in the October budget. While much of the discussion centers on pensions, Labour could also target other areas, such as capital gains tax or inheritance tax, to address the budget deficit. As the budget date approaches, we expect more information to become available.
Please note that this email is for informational purposes only and not intended as financial advice. If you have any concerns about your personal situation, we encourage you to contact your adviser for personalised guidance
By accessing the pension tax free cash based on speculation, you are making an important one off decision which could have an impact on your long term retirement objectives
The 25% lump sum would be based on present values and therefore you could miss out on future growth and the potential of a greater tax free lump sum in the future.
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