In Depth: Pension tax rumour mill in overdrive as chancellor faces difficult Budget balancing act

At the heart of the issue is the UK’s strained fiscal position. Public sector net debt was equivalent to 96.3% of GDP at the end of June 2025, with debt interest spending forecast to hit £111.2bn in 2025-26 – more than the schools budget.

Rising health and social care costs, defence commitments, and the net zero transition are adding further long-term spending pressure.

Against this backdrop, the Treasury is under pressure to find new revenue sources. Pensions, with their generous tax privileges and fast-growing cost to the Exchequer, are a natural target.

With Rachel Reeves due to give her next Budget in late October or early November, Pensions Expert explores the myriad rumours circulating about pensions taxation, and how they might be received.

Restricting tax relief on contributions

Data from HM Revenue & Customs (HMRC) shows gross pension income tax of £54.2bn in 2023-24. More than two thirds of this (68%) went to higher and additional rate taxpayers.

The Institute for Fiscal Studies (IFS) notes that limiting up-front relief to the basic rate would amount to a £15bn-a-year tax rise, but flags major practical issues for public sector defined benefit schemes.

The chancellor was rumoured to be considering this ahead of the 2024 Budget, but opted to leave it untouched after being warned of the complexity of enacting any changes. The Society of Pension Professionals also questioned how much any proposed change would actually raise.

“Changing pensions tax relief will be incredibly complex, time consuming and costly, leading to substantial disruption for savers, employers, the pensions industry and the UK economy,” the society stated in October last year.

Gary Smith, financial planning director at Evelyn Partners, says: “While this step would provide the greatest saving for the Treasury, and would be the cheapest to administrate, it would cause uproar among higher paid public sector employees – unless there was a controversial carve-out for the public sector – and do nothing to encourage pension saving among basic rate taxpayers. Indeed, the likelihood is that it would damage pension saving overall.”

Reducing the tax-free lump sum

Currently, up to 25% of pension savings can be withdrawn tax-free, capped at £268,275. The IFS has calculated that the cap could be cut to £100,000, a move that it estimates would raise around £2bn a year in the long run, with losses concentrated among those with larger pots. Transitional protections are likely to be needed.

However, Smith warns: “The suspicion that the pension commencement lump sum could be grabbed back in some way by the Treasury is a reason often cited for people giving up on pension saving after a certain point.”

“It is always disappointing to see leaks and rumours around the Budget that only serve to increase anxiety, decrease confidence and often result in unfortunate consequences for the public.”

Damon Hopkins, Broadstone

Damon Hopkins, head of defined contribution (DC) workplace savings at Broadstone, says recent news reports saying Reeves could make changes to tax-free cash were “surprising”, as previous chancellors explored this idea with no resulting changes.

“It is important that savers do not act in haste and later repent,” he adds. “It is always disappointing to see leaks and rumours around the Budget that only serve to increase anxiety, decrease confidence and often result in unfortunate consequences for the public, especially where the rumours don’t materialise.”

Curbing salary sacrifice

Salary sacrifice lets employees exchange part of their salary for employer pension contributions, lowering income tax and national insurance (NI), with employers also saving on NI.

Research commissioned by HMRC and published in May this year explored scenarios for removing NI, or both NI and income tax, which employers viewed negatively and feared would dent participation.

Steve Webb, partner at LCP and a former pensions minister, said in May that the research showed the government was likely to consider changes to salary sacrifice at the next Budget.

Ed Monk, associate director at Fidelity International, says: “There are a number of ways the government could limit salary sacrifice and recoup some of the tax revenue lost through these schemes.

“One option might be to cap the amount individuals can sacrifice – effectively targeting higher earners who are maximising these arrangements. However, the government could take a broader brush approach and remove the NI exemption, or both the NI and tax exemption, on all of these salary sacrifice payments.”

Inheritance tax on pensions

From April 2027, most unused DC pensions will fall within the scope of inheritance tax. The government expects to raise around £1.46bn a year by 2030.

However, industry commentators have warned that this could alter pension drawdown and gifting behaviour and create probate frictions if processes aren’t streamlined.

“It’s hugely disappointing that the government is pushing on with plans to bring pensions into the inheritance tax net by 2027, despite being warned about considerable problems with the proposals.”

Craig Rickman, Interactive Investor

Craig Rickman, pensions expert at Interactive Investor, says: “It’s hugely disappointing that the government is pushing on with plans to bring pensions into the inheritance tax net by 2027, despite being warned about considerable problems with the proposals.

“This could not only lead to poorer outcomes in retirement, but damage trust and confidence in a pension system that is already on shaky ground.”

Lifetime and annual allowances

The lifetime allowance was abolished in 2023 by the previous chancellor, Jeremy Hunt, after pressure from higher-earning public sector workers.

Before last year’s general election, the Labour Party explored reinstating this limit but backed down amid complexity concerns. However, rumours have resurfaced that the government could look again at restoring the lifetime allowance.

“If the chancellor can figure out a way of keeping well-paid NHS practitioners happy, then a cut to the annual allowance is a possibility.”

Gary Smith, Evelyn Partners

Reinstatement would raise revenue but risks re-creating problems for senior public-sector professionals and undermining policy stability.

Evelyn Partners’ Smith says: “It seems unlikely that the lifetime allowance will be resurrected, but if the chancellor can figure out a way of keeping well-paid NHS practitioners happy, then a cut to the annual allowance is a possibility.”

The big picture

The National Institute of Economic and Social Research’s latest outlook underlines the fiscal bind ahead of the Autumn Budget, with a projected current deficit of around £41.2bn in 2029-30 unless policy tightens.

The confirmed inheritance tax change is the clearest near-term revenue raiser; beyond that, altering tax relief or tax-free cash offers bigger sums but at higher political and operational cost.

The chancellor has yet to set a date for the Autumn Budget, but when she does, it is looking increasingly like a make-or-break moment for the pensions industry and the wider UK economy.

Additional reporting by Nick Reeve.