Reeves unlikely to cut pension tax relief for higher earners, says report

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UK chancellor Rachel Reeves is unlikely to cut pension tax relief for higher earners in her Budget next month because it would hit teachers, doctors and other better paid public sector workers, according to a report released on Monday.

Reeves had argued as an opposition MP for a flat rate of pension tax relief — a move which would significantly boost Treasury coffers — but a report by pensions consultancy LCP argues she will shy away from this move.

Sir Steve Webb, a respected former Liberal Democrat pensions minister and now an LCP partner, said cutting higher rate pension tax relief would hit a significant group of “mid-ranking and senior public sector workers — a group which the government is unlikely to want to alienate”.

The LCP report said that Reeves is likely to be taking a keen interest in pension tax relief — with a net annual cost estimated by the Treasury at around £48bn — but reform is fraught with political problems.

Currently, when people and their employers pay into a pension, their contributions are exempt from taxation up to a set annual limit.  

When savings are later withdrawn as pension payments, these are taxed like other income, with people able to usually take up to 25 per cent as a tax-free lump sum, up to a maximum of £268,275.  

George Osborne, former Conservative chancellor between 2010 and 2016, considered reforming pension tax relief in his 2016 Budget but dropped the plan after a fierce backlash from Tory MPs.

The LCP report said that Reeves is more likely to consider levying a rate of national insurance contributions on employer pension contributions, a change that would be less politically painful.

It noted that excluding these contributions from NI costs the Treasury a headline £23.8bn a year, and also encourages the practice of “salary sacrifice”, specifically to reduce NI bills. 

“The chancellor could create a new rate of NI — eg 2 per cent — on employer contributions, and raise a couple of billion pounds by doing so,” the report said. 

“The big advantage for the chancellor is that in most cases this would have no immediate pay packet effect on voters so would have lower political saliency. It could also be implemented relatively quickly,” it added.

Webb said: “The chancellor will be looking for relatively simple changes which can be introduced quickly and will raise large sums with least voter anger.”

In 2016, Reeves — then a backbench MP and a former shadow work and pensions minister — proposed setting a “flat rate of pension tax relief” at 33 per cent, below the 40 per cent tax rate paid by higher earners.

“This would be a welcome boost for basic rate taxpayers and a cut in the savings subsidy for higher earners, while still rewarding savings,” she said at the time.

The Treasury said: “We do not comment on speculation around tax changes outside of fiscal events.” Reeves has said that tough decisions lie ahead on spending, welfare and tax in the Budget.

The Labour manifesto committed the government to not increase taxes on “working people”, with specific commitment not to increase National Insurance, the basic, higher, or additional rates of Income Tax, or VAT.