This week saw the Westminster ‘Rumour Mill’ in full flow. Commentators and political pundits have been speculating on how the government will pay for the massive spending related to the Covid crisis. Taxes, and in particular the Lifetime Allowance, may be about to change. The cost of Covid is estimated to be around £360bn. The UK government is not alone in facing this dilemma, as many countries struggle to balance their books. There are only two realistic options:
- Increase borrowing.
- Increase taxation.
Increased borrowing
An increase in government borrowing will place a strain on public finances. Despite having the ability to generate large amounts of money through quantitative easing, this is not a viable long-term strategy. The UK is already up to its eyes in debt; adding to this could create inflation and put even more pressure on Sterling.
Increased taxation
Increasing taxation is rarely popular. Tory governments are particularly sensitive to raising taxes, as it goes against their political philosophy. However, this philosophy is debatable if we consider past and possible future treatment of the Lifetime Allowance.
The last Labour government introduced the Lifetime Allowance charge for pensions over £1.5m in 2006. It then gradually increased to £1.8m by 2010. The new Tory government left it alone for a year before reducing it step by step to £1m in 2016. The following four years saw annual increases based on CPI. In the 2021 budget, the current Chancellor suspended the annual increases for the remainder of this Parliament.
Increases in income tax are particularly unpopular, as apart from the obvious reduction people will see in net pay, it’s the tax that most people are aware of. This is problematic for governments, who never do anything without an eye on their ratings. Meanwhile, Inheritance and Capital Gains Tax changes are unlikely to make a great deal of difference to the Exchequer and are unpopular with Tory grassroot voters.
As rumour has it, the Chancellor is considering changes to pension taxation. Three options are being considered, all of which contain drawbacks:
- Change the Triple Lock. Currently, state pensions increase by the higher of 2.50%, wage growth, or the rate of inflation. As things stand, pensioners are in for a 6% increase to their state pension, as wage growth has increased massively due to the lifting of Covid restrictions for businesses. This gives the Chancellor a big and painful headache as he knows the country cannot afford it.
- Flat rate tax relief on pensions. Currently, tax relief is granted to pension contributions at the individual’s highest rate of income tax; relief of between 20% and 45% can be claimed. Potentially, this could be flattened out to only 20% for everyone and would generate receipts for the government. The problem is that it won’t raise any new revenue from those earning less than £50,000 p.a. and will be very unpopular with the higher earners, who are usually Tory voters. Headache for the PM.
- Thirdly, again according to the Rumour Mill, the Lifetime Allowance could be further reduced. Pundits are forecasting that the Chancellor might reduce it to as low as £800,000. The advantage to the government of doing this is that few people are aware of the Lifetime Allowance, and those who are, might consider it a tax on personal fiscal prudence. Why save for your retirement when the government is going to take a huge slice of your fund? An even bigger political problem for the government is that a reduction would further impact NHS workers, who have already seen their pension funds eroded by the Lifetime Allowance. This could pre-empt a flurry of retirements of top NHS personnel when the system is already under pressure, as a consequence of long-term under-funding and Brexit. Headache for the Health Secretary.
Based on the low-hanging fruit principle, some form of raid on pensions is expected. It’s happened before, and it will happen again.
Lifetime allowance solutions
The good news is that solutions are available for those who have pension pots that may breach the Lifetime Allowance. Fixed Protection 2016 is still available, and a QROPS transfer may be the best route forward for those living in the EU.