Pensions could see a boost from tax relief if chancellor Rachel Reeves goes ahead with lowering the higher and additional rate thresholds at her Budget on 26 November, as press reports suggest she might. The news has led to an increase in gilt yields this morning.  

Budget speculation is reaching fever pitch as the Financial Times reports today that the government has apparently U-turned on its intention to raise income tax by 2p and reduce national insurance by 2p, because the Office for Budget Responsibility’s forecast does not increase the fiscal deficit as much as initially feared. The report has pushed gilt yields up as markets show their disapproval of the latest about-turn.  

The Treasury now reportedly plans to reduce income tax thresholds, the FT says. It is widely speculated that the government will try to protect lower earners and only reduce the higher and additional rate thresholds. 

The 40% rate bites between £50,271 and £125,140; anything above is taxed at 45%. As well as paying a higher rate, those earning more than £100,000 currently have their personal allowance reduced by £1 for every £2 that adjusted net income is above £100,000, so the allowance reaches zero for anyone with income of £125,140 or above. This results in an effective tax rate of 62% for people earning £100,000. If they have children, earners at this level also lose child benefit and access to tax-free childcare.  

If the report of lower tax thresholds is true, even more people would see their marginal rate jump. While this will have a negative impact on take-home pay at a time when consumers are already cutting back, it could be an advantage for earners who decide to save into pensions.  

If the chancellor does cut thresholds, more people could expect to pay substantially lower tax by deferring income until retirement, when they might be in a lower tax band, observed WTW director David Robbins.  

 

However, he also warned that more higher rate tax relief would make tax relief on pension contributions appear more expensive for the government and lead to more speculation ahead of future Budgets. 

 

“Uncertainty about future tax rates and thresholds underlines that, although people can expect meaningful fiscal rewards for saving in a pension, the precise size of these rewards is unknown until the associated retirement income has been received,” he said. “Tempting as it might be to present tax relief as a simple top-up to the money that people save from post-tax income, this is far from the whole story.”

Cutting the thresholds would see the number of higher and additional rate taxpayers grow further from the current 8.3m, out of about 40m income taxpayers. 

The Institute for Fiscal Studies projects that just extending the threshold freeze until 2030 would mean one in four will be a higher rate taxpayer at that point. While earners can choose to save into pensions, those who are already retired do not have that option to the same extent. Their number is already relatively high; in May, LCP partner Steve Webb said 1m pensioners were 40% or 45% taxpayers. 
 

Thresholds were frozen in April 2021 by former chancellor Rishi Sunak, when previously they would rise in line with inflation. Jeremy Hunt later extended the freeze, currently due to end in 2028, and from April 2023 cut the additional-rate threshold from £150,000 to £125,140. Reeves is expected to continue the Conservatives’ policy of raising tax, keeping nominal thresholds, such as the basic rate income tax threshold, unchanged amid rising wages and inflation – a tactic thought to be less well understood by voters than headline tax increases.