The new Chancellor, Rachel Reeves, has set the date for her first budget - Wednesday 30th October.
Ahead of this, she’s warned of some “incredibly tough choices” to fill a £22bn fiscal hole inherited from the previous Conservative government, thereby paving the way for spending cuts and tax increases.
In this week’s blog, I look at the shape of the UK tax system; which taxes could be in her crosshairs; plus some of my thoughts and potential planning opportunities ahead of the Autumn Statement.
At various points, I reference the excellent Dan Neidle of Tax Policy Associates and his recent article: “How could Rachel Reeves raise £22bn of tax?” which is well worth a read – he writes far more eloquently than I ever could.
And I’m conscious that I wrote about this same topic just a few weeks ago, but a lot has changed since then. Most notably, there has been a clear shift in the narrative towards higher taxation.
The shape of the UK tax system
The task at hand – raising tax revenues – has been made all the more difficult, by the Labour Party ruling out increases to income tax, VAT or National Insurance.
As per the chart below, these collectively account for around two-thirds of the c. £1 trillion annual tax take in the UK.
That leaves little room for manoeuvre, in which case, we’re likely to see several relatively small tax increases here and there.
I focus on the four areas which would have the biggest impact on our clients – pensions; capital gains tax; inheritance tax; and ISAs.
How to raise £22bn?
1. Pensions
Within the pension regime, these three tax perks look the most susceptible to overhaul:
Tax relief on contributions
Under current rules, personal pension contributions qualify for tax relief at your marginal rate of income tax. Therefore, the effective cost of a £1,000 pension contribution is £800 for a basic-rate taxpayer, falling to £600 and £550 for a higher and additional-rate taxpayer respectively.
Some argue this unfairly benefits high earners and are pushing for a uniform rate of tax relief across all brackets, likely somewhere between 20-30%.
According to Dan Neidle’s article, a flat 20% relief would raise c. £15bn for the government, whereas a 30% rate would raise around £3bn.
Inherited pensions
Generally speaking, pension savings currently sit outside your estate and are therefore fully exempt from inheritance tax ‘IHT’. Furthermore, if you die before the age of 75, your nominated beneficiary can subsequently withdraw funds without any income tax to pay, whereas if you die aged 75 or over, they’d pay income tax at their marginal rate.
A quick and relatively simple policy change would be to include pensions in your estate, where they’d be liable to IHT of up to 40%.
According to the article, this could raise up to £1bn a year.
Tax-free cash
At present, once you reach Minimum Pension Age (currently 55, but set to rise to 57 by 2028), you can withdraw up to 25% of pension savings completely tax-free, up to a maximum ‘lump-sum allowance’ of £268,275. Any subsequent withdrawals are taxed as income at your marginal rate.
Some are calling for this to be scrapped entirely, others for a significantly reduced cap of say £100k, on the basis that this would only impact those with pensions valued over £400k, which is the minority.
A £100k cap on the tax-free lump sum would raise an est. £5.5bn a year.
Personal view: I think an overhaul of pension taxation is inevitable. That’s because the current system is pretty generous in terms of upfront tax relief and the ability to pass down any residual pension savings to the next generation completely free of IHT. It’s also one of the few areas where there’s scope to raise sizeable amounts.
I wonder if we get something on pension inheritability this Autumn, as that seems the most straightforward to implement. However, October may come too soon for the other aspects of pension taxation, which will require far more planning.
In regards to pension tax-free cash, I’d be very surprised if this went to £0, as it forms an integral part of many people’s retirement plans, most commonly to repay any outstanding mortgage debt. But a reduction in the limit to say £100-150k isn’t out of the question.
I think there is a relatively high probability of a harmonisation in the rate of tax relief on contributions, but I’d expect this at 25-30% (not 20%) as there needs to be enough of a carrot to encourage pension saving. Otherwise, you risk storing up problems further down the road, from a generation that is even more disengaged in pension saving than currently.
Disclaimer: A pension is a long-term investment and funds are not normally accessible until 55 (rising to 57 from April 2028). When investing via a pension, your capital is at risk. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
2. Capital gains tax
This has certainly received the most media attention over the last few weeks, mainly because Rachel Reeves has consistently refused to rule out any changes here.
The two parts of the current capital gains tax ‘CGT’ regime that looks mostly likely to be overhauled are as follows:
Equalisation with income tax
At present, the rate of CGT you pay on asset disposals is dependent on your taxable income.
The first £3,000 of gains are tax-free. Otherwise, capital gains falling within your remaining basic-rate income tax band are taxed at 10% (18% in the case of residential property), whereas those falling within the higher or additional rate bands are taxed at 20% (24% on residential property).
There are calls for Labour to equalise CGT rates with income tax, so 20% for basic-rate taxpayers, 40% higher and 45% additional. Indeed, this was a key feature of the Lib Dems’ election manifesto.
According to Dan Neidle’s article, this would raise around £1-2bn. He also makes the point that for this to be effective, it would need to be implemented overnight rather than at the start of the 2025/26 tax year, otherwise, everyone would ‘frontload’ asset sales to take advantage of the current (lower) rates, and its impact would be considerably diluted.
Removal/reduction of BADR
Business Asset Disposal Relief ‘BADR’ is a tax relief available to entrepreneurs, who pay just 10% tax on the first £1m of gains when they sell a business, as opposed to the standard 20% rate.
Removing this would raise an est. £1.5bn.
Personal view: I think we’re likely to get something here but it’s a ‘double-edged sword’. Set CGT rates too high and the UK becomes an outlier, prompting businesses to relocate elsewhere, at a time when we desperately need economic growth and entrepreneurialism.
My gut feeling is that BADR stays and we see either a modest increase in CGT rates (say a 5 percentage point rise), or an equalisation with income tax but with the reintroduction of ‘indexation’ – i.e. you only pay tax on gains over inflation, which would considerably ‘soften the blow’.
Disclaimer: The Financial Conduct Authority does not regulate tax advice. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts and their value depends on the individual circumstances of each investor.
3. Inheritance tax
Dan Neidle’s article cites two potential changes:
Business Relief
Under current rules, certain assets qualify for Business Relief and are therefore exempt from inheritance tax ‘IHT’ after two years.
This relief was originally introduced to enable family businesses to be passed down through multiple generations without incurring major tax charges. It was later extended (by Gordon Brown) to cover shares that aren’t listed on a recognised stock exchange, including the UK’s Alternative Investment Market ‘AIM’.
There has long been talk that this Relief could be scrapped or at least reduced (say from 100% relief to 50%), or the eligibility rules tightened – for example, only covering smaller businesses based on the number of employees, asset size, turnover, etc.
This could raise an est. £2bn-plus.
Periodic & exit charges
Discretionary trusts are commonly used by high-net-worth individuals as a tool for protecting their assets and mitigating IHT.
Trusts are subject to a 6% ‘periodic charge’ every ten years and another 6% ‘exit charge’ when the property leaves the trust (broadly pro rata to the number of years since the last ten yearly charge).
That seems generous in the context of the 40% IHT saved – an increase to say 9% would raise around £500m a year.
Personal view: These measures could be fairly presented as ‘closing loopholes’. However, Business Relief has been around for a long time and previous talk about ending this relief has been quickly squashed. I can see a tightening of the definition as to what qualifies for BR, but a full abolishment would fall into the ‘business unfriendly’ category and is therefore unlikely in my view.
Disclaimer: The Financial Conduct Authority does not regulate Inheritance Tax Planning. Inheritance Tax thresholds depend on your individual circumstances and may change in the future.
4. Reduction in ISA allowances
At present, you can pay up to £20k per tax year to an ISA, which shields any subsequent income or gains from tax. There are suggestions this could be reduced, say to £10k.
This would likely raise £1-2bn a year.
Personal view: I haven’t seen much on this but I think there’s a reasonable probability. In 2020-21, only 7% of ISA holders maxed out their annual allowance, so the burden would certainly fall on higher earners and would bring more investment into the taxable environment.
Conclusion & planning opportunities
There’s no denying that the current rules are pretty generous, in terms of pension taxation, ISA allowances, and the favourable CGT regime.
I personally don’t think taxes will rise that much – we’re already at a post-war high in terms of the overall tax take, and the new Chancellor will be desperate to avoid introducing any new policy that could hinder economic growth.
But some tweaking around the edges seems inevitable.
Whatever happens, we’ll be keeping a very close eye on this over the coming months and will be on hand to advise our clients accordingly.
Previous budget announcements have been widely leaked ahead of the event, so it will be interesting to see if this is the case again, or whether Rachel Reeves keeps her cards close to her chest.
In terms of planning opportunities, it’s straightforward – for those with sufficient surplus income and/or cash, make the most of available ISA and pension allowances whilst you still can.
Disclaimer: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
