Following our big day out last week when we all logged our vote on which political party we want to see govern the country for the next five years, our attention as financial planners turns to what changes may happen that will affect our clients.

With the change in political party from Conservative to Labour I have been discussing with several clients the big tax allowances they hold, which if removed would be problematic.  The biggest is tax-free cash from pensions.

What is tax-free cash?

Pension savers have a perk when beginning retirement that they can withdrawal the first 25% of their pension fund as a tax-free lump sum.  The balance of their pension fund is then drawn less income tax and taxed pursuant to the income tax bands.

^#FYI the nasty 60% tax band has been there getting wider and wider since Alastair Darling bought introduced it in 2009 and no Chancellor has the willingness to do anything about it.

What has been said about the future of tax-free cash?

My pensions career started in January 2001, and I cannot recall a budget time where there wasn’t an article written about this.  Indeed, there are many newspaper column inches and now online articles written by individuals who claim to know for certain that this allowance is to be withdrawn and you should “use or it lose it!”

When we read the political manifestos, transcripts of parliamentary discussions, and occasionally the odd note from parliament committee meetings, the subject is always absent.  Not guilty by its omission but perhaps that it is such a polarising viewpoint not endorsed by many (if not any).

While I have read several articles written by journalists on the subject of discussing what changes the new government could do to increase tax revenues to fund spending plans, the removal of tax-free cash does not immediately fit with the narrative of increasing tax revenue.

What happens if tax-free cash is removed?

Firstly, if the tax-free cash element is reduced or removed, individuals would be highly unlikely to replace this with a taxed lump sum.  So, there would be no additional tax revenue created. Indeed, more capital would be locked inside pensions which would benefit from tax reliefs.  This is unlike the loss of personal allowance tax charge by Mr Darling (aka Mr 60%) which was an instant addition to the coffers.

The withdrawal of tax-free cash is ordinarily linked with a purchase of some kind or it is deposited as cash and therefore earns interest which is taxable.  Putting a block on tax-free cash would therefore be a tax reducer.

Political suicide by removing tax-free cash

Many pension savers (if not all) are aware that irrespective of them being a member of a private pension or a final salary pension scheme that they have an entitlement to a tax-free element at the commencement of retirement.  The closer you get to retirement age, the more attention you pay to your benefit statements.  It’s removal or capping (two matters discussed with clients) would at best dampen the mood around an individual’s retirement or at worst make then negatively inclined towards the government who made the change.

You may remember that Gordon Brown was accused of raiding pensions in his first budget as chancellor.  In fact, he is widely credited with destroying final salary pensions in this budget with the removal of the pension tax relief on dividends.  This had a huge ripple effect into the final salary pension scheme marketplace and some have directly attributed this tax to the collapse of many schemes.  While the latter may be a harsh accusation, a quick Google search will still see the story being run in 2024!

If you think about increasing life expectancy and the spiralling cost of providing an income for life, if you stop final salary pensions paying tax-free cash, you force the final salary pension to pay a higher income for longer, which would have to be met by more assets on the balance sheet.  While the Treasury would enjoy additional tax revenue from the increased income paid, they might just kill off the remaining final salary schemes all of whom would then revert to government support!

To me, this would be akin to scoring an own goal in the FA cup final, then simultaneously kicking yourself in the shin repeatedly for decades to come.

With a new Labour government taking their seats this week on the back of a landslide victory, I would assume they will look to avoid the early own goals of their predecessors (while I think of Gordon Brown and Alastair Darling here, others may think of Liz Truss and Kwasi Kwarteng) and keep a steady ship for a while.

No changes expected

The pensions arena is incredibly complex and over the last 27 years of change, I would also say it is now incredibly delicate both from a tax structure standpoint.  I don’t think this is a secret to the Treasury, so I expect no changes to the tax-free cash regime for now.

If I could give any advice to the incoming Chancelor, it would be to work with what you have for now as you don’t have any low hanging fruit.  If economic growth and prosperity continue for the next 2 years throughout this decreasing interest rate cycle, the increased taxes from an increase in turnover should be good enough.

Or better still make Starbucks pay some tax.  Last year they paid £7.2M in tax against a gross profit of £149M in the UK.  Thanks a latte.

Enjoy the journey pension savers!