Why even at 20 you should care about pension changes

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There is growing speculation that the way pensions are taxed could be changed in the Budget.

Chancellor Rachel Reeves says she needs to find £22bn and some experts say she could change the system on workplace or private pensions to find some of this money. This is separate from another debate about the state pension.

There are a number of options which could affect workers getting their first job, those already working, all the way up to those in retirement. This is what could happen and why you should care even if you're only in your 20s.

When you get paid, national insurance (NI) is deducted and the government spends it on things like benefits and public services. Your employer has to pay a NI contribution too.

However, money that goes into a pension is free from income tax and NI.

One option for the chancellor is to make employers pay at least some NI on the money they put into workers' pensions.

Doing so could immediately raise billions of pounds for the government.

However, this extra cost to business owners could leave them with less money to spend on hiring and investing. It could therefore become harder to get a job.

Businesses could also limit pay rises, hitting all their workers, or reduce the pension contributions they make for new staff.

Alternatively, employers who currently make the most of the NI break by encouraging workers to take less in pay and more in pension - known as salary sacrifice - could be stopped from doing so.

The attraction of this option for Ms Reeves is that she can raise money without a visible difference to people's take-home pay.

The downside is it creates less of an incentive for employers to put money into their staff's pensions. That would mean when current workers retire they wouldn't have as much income.

Various rules exist when inheriting money from partners or parents when they die.

Inheritance tax is paid if an estate is valued at more than £325,000 but any money saved in a pension does not count towards this.

Separately, anyone who dies before the age of 75 can usually pass on what is left of their pension savings tax-free as a lump sum, or an income.

If they are 75 or older when they die, their pension money can still be passed on, but it is treated as income and the person they leave it to may have to pay income tax. There is more on these rules here.

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Removing these tax breaks would give the government more money, but exactly how much is unclear. The vast majority of people don't pay inheritance tax anyway because they are not left estates worth more than £325,000.

There could also be anger from people who have organised their finances under the current rules, only to find their loved ones would get a lot less if those rules changed. That anger would be even greater among those who have already retired, as they have less time to do much about it.

From the age of 55 (or 57 from 2028), anyone with pension savings can take a quarter of their money as a tax-free lump sum up to a maximum of £268,275.

Some use that money to pay off their own mortgage, if they have one. Others use it to help children and grandchildren buy a first home.

The chancellor is said to be considering lowering the cap.

By limiting the tax-free limit, people will eventually pay more in income tax when they take their pension. However, there are questions over how much extra money that would raise for the government and when.

Making arrangements for those who have already exceeded the limit, or were planning to, could also be complex, and reduce how much extra tax the Treasury gets.

The build-up to every Budget usually sees speculation about changing pension tax relief.

When you pay into a pension, some of the money that would have gone to the government in tax goes into your retirement savings instead, known as pension tax relief.

You don't pay tax when putting money into a pension but you do when you come to take that money as income.

Under the current system, you receive pension tax relief at the same rate as your income tax bracket - meaning basic rate taxpayers receive relief at 20%.

That means for higher rate taxpayers, the relief is more generous, at 40% or 45% in line with your income tax rate. You can read more about how this is done here.

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Some economists say it would be fairer to give the same level of relief for everyone.

Setting a flat-rate of relief at, say 25%, could benefit lower-earning employees who currently get 20% relief, by further reducing their tax bill.

However, higher rate taxpayers with an annual income of about £50,000 or more would lose out, because tax relief would be lower than now.

An added, but important, complication is that a huge group of public sector workers, and some in the private sector too, have so-called defined benefit (DB) pensions.

Ensuring the correct level of tax relief is applied to higher-rate taxpayers with these pensions would be highly complex.

It may mean they are automatically given 40% or 45% tax relief, then later handed a tax bill - possibly for thousands of pounds - to pay some of that back.

Tom Selby, from investment platform AJ Bell, says this would likely provoke "a blistering row" with NHS staff, teachers and civil servants who could fall into this bracket.

Given that ministers have said they will not raise taxes for working people, that would become a tricky policy to sell - and reports suggest changes have now been ruled out by the Treasury.