Pensions have increasingly been in the spotlight as successive governments have realised the enormous potential they could present to struggling public finances. While their primary purpose has always been to fund the retirements of UK workers, pensions have been repurposed for all manner of things, from reducing tax liabilities, to protecting individuals’ wealth, to investing in sustainability initiatives; savers, regulators, and industry experts will therefore be keen to understand what this Government has in store for pensions on 26 November 2025.
A Tax Incentivised Savings Vehicle
As it stands, the UK pension system offers significant tax incentives to encourage saving for retirement. Under the current rules, individuals receive tax relief on pension contributions at their marginal income tax rate (20%, 40% or 45%), either by way of a tax return or through net pay arrangements with their employer where the relief is applied automatically via PAYE. Removal of this relief at marginal rates, and instead a flat rate of pension tax relief, is one possibility that is regularly floated, though this would likely be complex to implement for net pay arrangements.
Employees saving for a pension via a workplace arrangement may also do so via salary sacrifice. Where a salary sacrifice arrangement is in place, for income tax purposes the pension contribution is treated as being made gross by the employer with the employee receiving the full income tax relief at source. This means the employee’s taxable pay is reduced by the amount sacrificed before it is taxed under PAYE. The arrangement also results in National Insurance savings for both the employer and employee, which some employers pass back to their employees by way of enhancing the pension contributions further.
While this makes pension contributions an attractive workplace benefit, there been some speculation in the media about potential reforms to salary sacrifice agreements, with HMRC publishing new research on employers’ attitudes towards using salary sacrifice arrangements for pensions in May this year. Potential changes could therefore include removing the National Insurance exemptions, or perhaps capping it to the first £2,000 of sacrificed salary.
Income Tax Relief and Potential Restrictions
Income tax relief for pension contributions is currently limited to an ‘annual allowance’; both employee and employer contributions are tested against the annual allowance which has been £60,000 since 6 April 2023. This is increased by any unused allowances of the previous three tax years if the individual was a member of a registered pension scheme in those years. For individuals with high income, the annual allowance is generally reduced by £1 for every £2 of income above £260,000 but cannot be reduced to below £10,000. Where the annual allowance is exceeded, the income tax relief is clawed back by an annual allowance tax charge.
The maximum contribution an employee can obtain tax relief for in one tax year is 100% of their ‘relevant earnings’ for that year. Relevant earnings means earned income rather than passive investment income. However, there is no such restriction where the employer makes the contribution, but it is unlikely the employer would be making such a large contribution for a regular employee.
For certain individuals, pension contributions can be used to mitigate the High-Income Child Benefit Charge by reducing ‘net income’ to below the £60,000 threshold. They can also be useful for reducing ‘net income’ to below the £100,000 threshold with regards to eligibility for tax-free childcare and to preserve the full tax-free personal allowance of £12,570.
Wealth Planning
As individuals approach retirement, many will have built up substantial pension pots, and thus they have been attractive ways to build wealth. Most people can start accessing their pensions from age 55 (rising to 57 in 2028) with 25% available to draw down as a tax free lump sum (up to £268,275), and in April 2024, the last government removed the lifetime allowance which previously capped the total value of pension savings that could benefit from tax relief.
In the 2024 Autumn Budget, the government introduced measures to prevent pensions being used as a tax planning vehicle to transfer wealth. For deaths on or after 6 April 2027, pensions will now be subject to inheritance tax. As a result, it has become less attractive for individuals to accumulate unlimited tax-free savings in their pension, and they will likely draw on other means to fund their retirement and pass their unused pension assets to beneficiaries.
As this year’s Budget approaches, there have been stories around a potential cut to the tax-free pension lump sum ‘raid’ in the upcoming Budget. This speculation around potential changes is creating uncertainty for pension investors who need clarity over the tax system to enable effective financial planning.
Workplace Pensions and Auto-Enrolment
While many of the speculated pension reforms could have significant impact on savers, businesses and employers may also see some changes. All employers must provide workplace pension schemes, automatically enrol their employees into a pension scheme, and make contributions to that scheme if an employee is classed as a “worker”, aged between 22 and state pension age, earns at least £10,000 per year and usually works in the UK. From April 2019, the total minimum contribution has been 8% of earnings (3% from the employer and 5% from the employee). Employers can pay more, meaning that employees can pay less, provided the overall balance is 8%. There have been calls from the Pensions and Lifetime Savings Association for the Government to increase minimum contributions over the next decade so that employers pay the same percentage as employees, with pensions adequacy being a key focus of the new Pensions Commission. The impact this could have on UK businesses remains to be seen, with reforms of this scale unlikely to come about in this year’s Budget.
While speculation continues about potential reforms to pension tax relief, salary sacrifice arrangements, and tax-free lump sums, it’s crucial to remember that no changes have been confirmed ahead of the 2025 Autumn Budget. The uncertainty surrounding such proposals has already prompted some savers to make hasty decisions about accessing their pensions early, a move that could have significant consequences for their retirement pots. Pensions remain one of the most tax-efficient vehicles for long-term saving, even if some reliefs may be scaled back.
Whatever changes emerge from the Budget, they may include transitional arrangements and protections for existing savers. Savers should focus on their long-term retirement goals, and seek professional advice before making any decisions about pension planning.
We’d love to hear from you. To book an appointment or to find out more about our services:
