How might Labour’s pension plans impact your retirement?

There’s been a lot of talk around how Labour might change the rules on pensions in the upcoming Autumn Budget. Rules could change around tax relief, tax-free cash, or even pension treatment for inheritance tax.

We could also see adjustments to the way pension funds invest, with Labour’s election manifesto committing to “act to increase investment from pension funds in UK markets.”¹

This would reverse decades of pension funds drastically reducing their exposure to the UK market. Since the removal of the dividend tax credit (which incentivised investment into UK companies) in 1997, the share of UK equities owned by pension and insurance companies has fallen from 45.7% down to just 4.2% in 2022.²

Using pensions to drive investment into UK companies

For many years, investors in UK companies received a 10% dividend tax credit on their dividend income, which provided an additional incentive to invest locally.

There’s no specifics yet on how the government plans to increase institutional investment into UK equities. What we do know is that the comments so far have centred around ‘encouragement’ rather than any mandatory investment limits.

This an interesting issue to consider, given that UK pension schemes (including defined benefit, defined contribution and local government pension schemes) manage over £2 trillion in assets.³

Large inflows from institutional investors could have a notable demand-pull effect on the share prices of UK companies in the short term.

But with the UK market underperforming many other major markets in recent years (notably, the US) would this be a positive for long-term retirement savings? Or would it mean pension funds are left holding a higher proportion of underperforming UK assets than they otherwise would?

How changes to pension investments could affect retirement savings

Pension trustees (who are in charge of appointing investment managers for the scheme) must make investment decisions that are in the best interests of their members, both present and future.

This presents a challenge for the Labour government. In order for pension trustees — and the investment managers they appoint — to invest more into UK companies, there needs to be a compelling investment case. They need to be able to realistically feel that it’s a move that is in the best interests of their members.

Not only that, but with many investors now taking control of their own pension savings by investing in private pensions such as Self-invested Personal Pensions (SIPPs), retirement savers can decide how much of their pensions they allocate to UK assets.

It could be good news for pension savers. The government is going to have to provide a significant ‘carrot’ to investors and investment managers in order to create real change, which could present an opportunity for additional returns.

And if the changes are successful in their broader aims of increasing the attractiveness of UK companies for investors and driving growth of UK assets, there’s potential for far-reaching benefits beyond pension returns.

According to Gary Smith, Partner, Financial Planning at Bestinvest parent company Evelyn Partners, this isn’t the main pension change that people should be worried about.

“The bigger risk in the lead up to the Autumn Budget is changes to pension tax relief and tax-free cash, which would have far-reaching consequences.”

Labour’s pension plans and tax

While underlying changes to investments within a pension can potentially improve returns, big changes to pension taxation could have a far more dramatic impact.

It’s important to note that at this stage there are no confirmed changes to pensions tax, and we won’t know the full details until 30 October 2024. If you want to understand your options and how all of this might be relevant to you, you can speak to a Bestinvest Coach.

There are, however, some options for Chancellor Rachel Reeves to consider.

Will Labour remove tax relief on pensions?

One of the most widely speculated of these is a reduction of tax-relief on pensions. Currently, defined contribution schemes receive basic rate tax relief directly into the pension fund balance (known as ‘at source’), with higher and additional rate taxpayers able to claim further tax relief at the end of the tax year.

This tax-relief could be limited to the basic rate only, or another flat rate provided to everyone, regardless of earnings. But Smith points out that the practical implementation of this could be difficult.

“Changing pension tax relief for the private sector is relatively simple because you can just remove the ability to claim back higher or additional rate relief each year. But the public sector — like the NHS and teachers’ pension schemes — doesn’t work that way.”

Public sector tax relief is calculated and processed on what’s known as a ‘net pay’ arrangement, where less tax is deducted from salary and wages. This is different to the ‘at source’ arrangement for the private sector, where tax is paid normally and then refunded.

This means that to change pension tax relief fairly would require all public sector schemes to transition from a ‘net pay’ arrangement to an ‘at source’ arrangement.

Will the pension tax-free lump sum be scrapped?

Labour have stated that they do not plan to make any changes to tax free cash.

It’s highly unlikely the pension tax-free lump sum will be scrapped, but many experts believe Chancellor  Reeves could consider reducing the maximum amount which can be withdrawn.  Pension tax free cash (officially known as the pension commencement lump sum — PCLS) is currently set at 25% of your pension balance, with an upper limit of £268,275.

Could Labour charge inheritance tax on pensions?

Labour could potentially add inheritance tax (IHT) on pensions, which are currently exempt from it. Many financial advisors manage their clients’ assets around these rules, aiming to draw down on accounts that are subject to IHT first (such as ISAs and general investment accounts) in order to maintain a higher proportion of wealth in pension assets with are exempt from IHT.

Any changes to this area would likely result in the need for amendments to retirement funding plans for many retirees .

The bottom line for retirement savers

It’s likely that we’ll see some significant changes to pension legislation. The options listed above are just some examples of what the Chancellor may be considering, with many more ideas likely under discussion behind closed doors.

Smith adds, “We could see a major shakeup to the pension system in the Autumn Budget. I’m having conversations with all my clients at the moment on how we can get ahead of these changes and take advantage of the current rules while we can."

“There’s precedent for new rules coming into force the day of the Budget (as opposed to a notice period before the change occurs) , so we don’t want to get caught on the back foot. Forward preparation is going to be key to limit the impact on retirement plans.”

Sources

¹ 2024 Labour Manifesto, Kickstart economic growth, June 2024

² Office of National Statistics, Ownership of UK quoted shares, 4 December 2023

³ Pensions and Lifetime Savings Association, Pensions and Growth June 2023, June 2023