Pension tax relief and salary sacrifice schemes could be affected at the Chancellor’s Budget
Rachel Reeves’s Budget later this month could reshape the tax landscape for pension savers and retirees.
The Chancellor warned that “we will all have to contribute” as she searches for up to £30bn in extra revenue to plug a hole in the public finances.
Reeves said those with the “broadest shoulders” should pay more, signalling that pension tax reliefs and retirement income could come under renewed scrutiny.
These are among the measures expected to feature in a Budget that could mark a turning point in how pensions and retirement income are taxed.
Capping salary sacrifice pension contributions
The most immediate change likely to appear in the Budget is a new limit on how much employees can divert into their pensions through salary sacrifice before paying national insurance.
Under current rules, there is no ceiling on the amount of salary that can be exchanged for pension contributions without incurring national insurance contributions (NICs).
The arrangement benefits both workers and employers – employees reduce their tax and NICs bill, while employers avoid paying NICs, usually 15 per cent, on the portion of salary redirected into pensions.
According to reports in The Times and the Financial Times, Reeves plans to cap this benefit at £2,000 a year.
Employee contributions above that threshold would be subject to national insurance at standard rates – 8 per cent for earnings below £50,270 and 2 per cent above it.
It has been estimated that the move could raise around £2bn annually. The most significant impact would fall on higher earners who make large additional pension contributions through salary sacrifice – employees are recommended to save at least 15 per cent of their salary for retirement.
An income tax rise that would hit pensioners
The most politically sensitive measure under consideration is a 2p rise in the basic rate of income tax – potentially from 20 per cent to 22 per cent.
Some expect that the increase could be balanced by a 2p cut in national insurance on earnings between £12,571 and £50,270, effectively cancelling out the change for most workers.
But pensioners would not benefit from this offset, since they do not pay national insurance. As a result, almost nine million state pensioners could face higher tax bills.
HMRC figures obtained by pension consultancy LCP show that more than one million pensioners already pay higher or additional rate income tax.
For those earning above £125,140, whose tax-free allowance is removed, the change could mean an extra bill of more than £2,500 a year.
Accountancy firm Blick Rothenberg estimated that a pensioner with an income of £27,500 would pay around £298 more tax a year if the basic rate rose to 22p.
Tax changes for landlords
Another proposal that could affect many older savers concerns landlords, many of whom are pensioners.
Currently, rental income is not subject to national insurance, and landlords can still benefit from a range of allowances even after paying income tax on their profits.
The Resolution Foundation and the Centre for the Analysis of Taxation have both suggested closing this gap by bringing landlords into the national insurance system.
One option reportedly under review would impose a 20 per cent rate on rental profits up to £50,270, and 8 per cent above that – similar to the rates paid by employees – which could raise around £3bn a year for the Treasury.
Analysts say such a change could raise up to £3bn a year, while ensuring landlords “contribute in line with workers”.
However, for retired landlords who rely on rental income to supplement their pension, the effect would be direct. Even modest portfolios could face annual bills running into thousands of pounds.
Possible cuts to the 25 per cent tax-free lump sum
Rumours have persisted for months that the Chancellor could also review the long-standing rule allowing savers to take up to 25 per cent of their pension pot tax-free, up to a limit of £268,275, once they reach the age of 55.
Though it has not been confirmed whether the measure is being considered, speculation over the change has already prompted a surge in withdrawals.
Investment platform Bestinvest said it saw a 33 per cent rise in self-invested personal pension (SIPP) withdrawal requests in September compared with the two-year average, while interactive investor reported a 61 per cent year-on-year increase in tax-free lump-sum withdrawals.
Tax expert Eamon Shahir told The i Paper that some savers were acting early “to lock in today’s generous rules”, using the money to pay off mortgages or gift to children. But others, he warned, were “acting out of fear, not strategy”.
Although no firm proposal has been tabled, the Institute for Fiscal Studies has previously suggested reducing the limit to £100,000, which could save the Treasury billions over time.
Ending higher-rate pension tax relief
Reeves is also reported to be examining changes to pension tax relief – the system that currently allows people to receive relief at their marginal tax rate.
Basic rate taxpayers get 20 per cent relief on contributions, higher-rate taxpayers 40 per cent, and additional-rate taxpayers 45 per cent.
For example, if a basic rate taxpayer were to pay £100 into their pension, the Government would then pay an additional 25 per cent.
The Chancellor could replace this with a single flat rate of around 30 per cent for everyone, which would make the system more progressive but reduce the incentive for higher earners to save.
A report by LCP, co-authored by former minister Steve Webb, warned that cutting higher-rate relief could have “unintended consequences”, particularly for public sector workers with generous defined benefit schemes.
The report said such a move risked “hitting the public sector especially hard” and “undermining pension saving” while raising less revenue than expected in the short term.
Including pensions in inheritance tax from 2027
Although not a new announcement, another measure affecting retirement planning is already scheduled to take effect in April 2027.
Under changes announced at the last Budget, unused defined benefit pension savings will be included in a person’s estate for inheritance tax purposes.
The shift has already altered behaviour among older savers. RBC Wealth Management said its recent survey found 56 per cent of wealthy pensioners planned to spend more of their pensions following the change. Some have started gifting larger sums to family members to start the seven-year countdown for the gifts to become tax-free.
Andrea Tarasheva of RBC, told The i Paper: “In some extreme cases, individuals are deciding to take out larger amounts and gifting large sums to family members. They are doing this in the hope that it will begin the seven-year countdown for the gifted funds being exempt from IHT.”