The new Labour government isn’t wasting any time. October’s budget could bring some major changes. What could be at risk? Let’s explore the possibilities.
In July, a new Labour government took power and announced that its first budget would be in October. We’ve had many concerned queries from our clients, so we have created this update to cover the background, what has already changed, and what the government could be looking at ahead of the October budget.
The Chancellor of the Exchequer pulls out the red box annually, outlining the state of the economy and proposed changes to taxation.
For many years, we have grown comfortable with budgets that make tweaks around the edges, and often have one or two “rabbit out of the hat” moments, but overall, not a huge shake-up each year. Given that the Conservatives were in power for 14 years, they wouldn’t make huge changes as they’d be ripping up their own rule book, which they have crafted over 14 years.
So, why do we think there are big changes afoot now?
In the first few weeks of the new Labour government, the Chancellor of the Exchequer, Rachel Reeves, stated there is a £22 billion black hole. This is £22bn of spending commitments this year that aren’t funded.
Furthermore, in August, the Office for Budget Responsibility (OBR) released a report that confirmed that borrowing for the first four months of the tax year (2024/25) is above forecast by £4.7billion. This is driven by growth in public sector pay.
The government don’t want to borrow more to fill these gaps, as they have self-imposed fiscal rules to follow. Specifically, that debt must be falling as a share of the economy by the fifth year of their forecast. Therefore, the government has two options: cut spending or raise more. They could take the austerity route and spend less; this seems unlikely, given that public services such as the NHS are in need of support, and that Rachel Reeves ruled out a return to austerity in a Labour Party conference speech. In the absence of making cuts, they can find the balance by raising more via taxes.
This message has been reinforced by Keir Starmer, who said there would be some painful decisions in October, and, after D:Ream reportedly said they would deny any request for their popular track “Things Can Only Get Better” to be used at the 2024 election, Starmer said that things would get worse before they get better.
Labour won’t be precious over any existing plans, simply, those plans belong to the opposition, so we can expect to see some changes in October.
The Chancellor has given us a long run-up to the budget, giving the government breathing room to test the waters with some changes before they happen, for example, dropping hints or confirming that a certain area of policy isn’t off the table.
When they were campaigning for government, the Labour Party made some promises. Firstly, to “not raise taxes on working people”, specifically Income Tax, National Insurance or VAT. Secondly, to keep the State Pension triple lock in place – this means the state pension will increase each year by the greater of inflation, average earnings, or 2.5%. For example, in April 2023, the State Pension increased by 10.1% (which was September’s inflation); however, by the following year, inflation had tempered, but average wages were high, seeing an 8.5% State Pension increase this year. The State Pension is expected to increase by 4% in April 2025, in line with average earnings. Therefore, we are unlikely to see changes to the triple lock, or increases to National Insurance, Income Tax or VAT in the short-term without a mighty justification.
However, in order to patch the black hole, something will need to change. Let’s look at what has already been changed, and what could be changed.
Winter Fuel Payment
While we believe that the direction of travel is broadly to raise more rather than make cuts, one of the early announcements was a hugely unpopular cut to winter fuel payments.
The winter fuel allowance was introduced in 1997. It is an annual payment of £200 or £300 for pensioners. Reeves announced that those not on pension credit or other means-tested benefits will no longer get the payment. This decision felt like a taste of further controversy to come.
British ISA
The British ISA: blink, and you will have missed it. This additional £5,000 ISA allowance to encourage investment in British companies was launched earlier this year by the then-Chancellor Jeremy Hunt and has now reportedly been scrapped.
We can’t say for sure what the October budget will bring, but we’re keeping an eye on a few key areas that might see changes. Whilst we don’t have insider information, we want to share some of the possibilities being discussed. So, let’s dive into what could be on the horizon and what it might mean for you. Here are some of the areas that we are watching:
Pension Lump Sum
In the run-up to the budget, we are receiving more and more queries from clients on the speculation surrounding the possible changes to tax-free cash entitlements in pension funds. Currently, the tax-free cash entitlement, or “lump sum allowance”, is capped at 25% of your unused pension funds (up to a maximum lifetime limit of £268,275 across all pension schemes). There are now concerns that this pounds and pence limit, or indeed the percentage, could be reduced in the near future; this would mean that more of your pension savings would be taxable when they are drawn.
It is a generally recognised principle that tax legislation changes should not be retroactive; this means that, should there be any reductions in the allowances, they may only apply to pension savings accrued after a certain date. However, this is not guaranteed, and so we will be keeping a close eye on these developments.
Minimum Pension Age
The current normal minimum pension age is 55 and is set to increase to 57 in 2028. As the name would suggest, this is the youngest age at which most people can access their pensions, put in place to avoid the temptation of perhaps pulling some money out of a workplace pension at age 40 because you need a new car.
There has been talk that Labour might increase the minimum age again. This will make retirement funds last longer, and also benefit the economy, given that there will be some increased labour market participation.
Now the change from 55 to 57 was announced in 2014, set to kick in in 2028, a 14-year run-up. Therefore, we would expect that any announcement now would take effect sufficiently far enough into the future to ensure that those who wish to retire early have time to plan.
When it was announced that the minimum pension age was to rise to 57, it was done to coincide with the rise in State Pension Age to 67; the idea being that the minimum pension age would be State Pension Age minus 10. If this relationship is to continue, then a rise in the State Pension Age could impact a further rise in the Minimum Pension Age. A recent study by the International Longevity Centre suggests that State Pension Age could rise to 71 by 2050, which could mean a hike in the Minimum Pension Age to 61 at the same time. This is all still conjecture, however.
Hopefully, should you be hoping to retire early, not all of your retirement provisions will be locked away in a pension fund; for example, you may also have investments in an ISA, so the impacts of any potential changes here would only mean a change to how you fund your retirement, rather than it being a factor that determines whether you can or cannot retire.
Still, this won’t patch the hole we’re facing now, so what might?
Pensions and Death Tax Treatment
Pension pots usually fall outside of an individual’s estate for Inheritance Tax purposes, meaning they’re typically not subject to Inheritance Tax. Instead, on death before age 75, pension savings can typically be paid tax-free to beneficiaries, and after age 75, taxed at the beneficiary’s marginal rate.
This could be an area for the government to target to increase the tax take for two reasons:
- If a higher tax were levied on pensions upon death, and individuals didn’t change their behaviour by drawing more from their pension in their lifetime, then the government’s tax take would be increased through a potential higher tax paid by the beneficiaries on death, or
- If a higher tax were levied on pensions upon death, and individuals then decided to draw more from their pensions in their lifetime, the government would likely see more tax revenue from a greater income taken.
If we were to see changes in this area, it could be significant for financial and estate planning.
Flat Rate Tax Relief
We’ve talked a lot about money coming out of pensions, but what about money going in?
Currently, pension contributions benefit from tax relief, the amount largely depending on how much tax you pay. i.e., you get tax relief up to your marginal rate. So, a £100 pension contribution will cost you varying amounts, depending on your rate of tax. For a basic rate taxpayer, it would cost £80, but for a higher rate taxpayer, it would cost £60. There has been speculation that the Labour government could introduce a flat rate of tax relief, for argument’s sake, let’s say 25%. If this happened, it would cost £75 irrespective of tax band, a benefit to those paying basic rate tax, but not those paying more.
Whilst this is theoretical, in the tax year 2020/21, pension Income Tax and National Insurance tax relief cost almost £70 billion, so changes in this area could harvest some chunky returns.
Capital Gains Tax
As mentioned earlier, Labour campaigned for government under the promise of no increases to the main rates of Income Tax, National Insurance or Value Added Tax (VAT). They did leave the door wide open, however, for Capital Gains Tax changes.
Capital Gains Tax (CGT) is levied on the profit from the disposal of certain assets. The rate of tax is much lower than the rate for Income Tax, and therefore, there is potential for Labour to bring CGT closer in line with Income Tax. If CGT were aligned with Income Tax, for example, this would shift the tax rate of CGT up from the existing 10% for basic rate taxpayers to 20%, and from the existing 20% for higher rate taxpayers to 40%, doubling the tax liability across the board. Furthermore, additional rate taxpayers could have a further hike from the current 20% to 45%.
The annual exempt amount for Capital Gains Tax has already been slashed from £12,300 two tax years ago, to £6,000 last tax year, and £3,000 this tax year. This is the amount of capital gain that can be realised before CGT is levied. The latter should already be motivation enough to consider if you are making use of your ISA allowance – assets within an ISA grow without being subject to tax.
It’s crucial that your financial plan has the flexibility to adapt, ensuring it is robust and responsive to any legislative changes. Whether it’s adjusting for new pension rules, tax alterations, or shifts in the broader economic picture.
We hope you have enjoyed this discussion covering the background, what has been announced and some areas we are watching. Whatever the next Labour budget brings, we will be on it. We’ll break down the key announcements for you, and our financial planning and technical teams will go through the details. So, during your next financial planning meeting, we’ll ensure you have the right information and advice to stay on top of things.
Thanks for reading, and we’ll keep you updated!
