It’s no secret that tax rises are on the horizon. Rachel Reeves’s second budget is just two months away, and the chancellor needs to find more money — lots of it.
Long-term government borrowing hit a 27-year high this month, and the National Institute of Economic and Social Research, an independent think tank, last month put the gap in the public finances at about £50 billion.
The chancellor disputes this figure, but there is little doubt that Reeves and her team are searching for new ways to bring in much-needed cash for the Treasury. A series of U-turns since last year’s budget, such as the abandoned cuts to welfare and winter fuel payments, and lower than expected growth figures, have added to the pressure.
Part of the crunch stems from Reeves’s self-imposed “non-negotiable” borrowing rules. These dictate that day-to-day government costs will be paid for by tax income rather than borrowing by 2029-30 and that debt will start to fall as a share of national income by the end of this parliament. This ties the government’s hands.
And before the election Labour pledged not to increase taxes on “working people”, so Reeves would have to break a manifesto promise to raise the rates of the “big three” taxes: VAT, national insurance and income tax.
It is little surprise, therefore, that there has been widespread speculation that the chancellor and her right-hand man for the budget — the pensions minister Torsten Bell — are mulling a shake-up of the way pensions are taxed.
When Reeves was asked by The Sunday Times in 2016 which part of the tax system she would change, she responded: “Pensions tax.” In the lead up to last year’s budget, removing the 25 per cent tax-free lump sum and limiting the tax relief paid on pension contributions were both said to be on the table.
The Resolution Foundation, the left-leaning think tank previously run by Bell, has long campaigned for similar changes. In 2019 he described the tax-free lump sum allowance as “very generous” and suggested a cap of £40,000. One policy that was pushed by the foundation — making pension pots liable to inheritance tax — has already been adopted by Reeves.
As we draw closer to budget day on November 26, speculation over what could be announced is ramping up. Here, we outline seven things that the taxman could come after and talk to savers who are already preparing for the raid.
Salary sacrifice
This is a scheme where your employer allows you to swap part of your salary for another benefit, often a pension contribution. It is tax efficient because the money is never paid to you, so you do not pay tax or national insurance on the amount that is “sacrificed”. On standard pension contributions, you get income tax relief (at the basic 20 per cent rate — higher-rate taxpayers have to claim the rest back) but still pay national insurance.
Your employer also benefits because they save on the national insurance they have to pay on your income, so offering a salary sacrifice arrangement lowers their overall tax bill.
But the days of such schemes could be numbered. Earlier this year HM Revenue & Customs (HMRC) published research into how employers might respond if the government scrapped or capped the tax benefits of salary sacrifice.
Steve Webb, a former pensions minister who now works at the consultancy LCP, said it was “very revealing” that HMRC had paid for the study. “This suggests that changes to salary sacrifice are firmly on the agenda and likely to be considered as a potential revenue-raising measure.”
The wealth manager Evelyn Partners calculated that HMRC could lose £460 a year in tax if a worker earning £40,000 and paying 5 per cent into their pension (with an employer contribution of 3 per cent) shifted to a salary sacrifice scheme.
These arrangements are also beneficial for high earners who are above a tax cliff-edge, such as the £100,000 income threshold at which you begin to lose your £12,570 tax-free personal income allowance and a raft of other benefits, including free childcare. This aspect of the scheme wouldn’t necessarily disappear if the government removed the national insurance relief, but employers may be less likely to offer salary sacrifice if there was no tax benefit for them.
Pension tax relief
You get tax relief at your marginal tax rate on any money you pay into your pensions — so 20, 40 or 45 per cent depending on whether you are a basic, higher, or additional-rate taxpayer. Rumours have swirled, however, that Reeves and Bell could introduce a flat rate of 30 or even 20 per cent relief on pension contributions, slashing the benefits of saving for higher earners.
The Resolution Foundation has long called for such a change, and a report by the Fabian Society, another left-leaning think tank, last year said that introducing a flat rate of tax relief would make about £10 billion a year for the Treasury. The relief costs about £66 billion a year.
As it stands, a higher-rate taxpayer saves £400 of income tax for every £1,000 they pay into their pension pot. If the relief was capped at 20 per cent, this would drop to £200.
Sarah Coles from the investment platform Hargreaves Lansdown said: “If you are a higher-rate taxpayer and worried about changes, it’s a good idea to make the most of the system by making a contribution to your pension before the budget.”
At the moment you can pay in up to £60,000 a year (or 100 per cent of your salary, whichever is lower) and get full tax relief, and carry forward unused allowances for three years.
Pension income
Those over state pension age do not pay national insurance on their income — just income tax. National insurance is levied at a rate of 8 per cent on income between £12,570 and £50,270 and 2 per cent above this.
This week the Resolution Foundation urged Reeves and its former boss, Bell, to “level the playing field” between pensioners and workers by raising the rate of income tax by 2p in the pound while slashing national insurance by the same amount.
• Raise income tax by 2p to fill budget black hole, Rachel Reeves told
The move would have little impact on workers, but would primarily hit pensioners, landlords and the self-employed. About three quarters of pensioners already pay income tax, so would be affected by the change.
It would also hurt any pensioner who gets the full state pension because that is expected to be higher than the tax-free personal income allowance by 2027 and so would be taxable.
If this change was made, the best way to mitigate it would be to take your retirement income as tax-efficiently as possible.
If you are yet to reach state pension age (and the 25 per cent tax-free lump sum rule does not change) you could take £16,760 from your pot each year without paying any income tax — a quarter would be tax-free, the rest falls within your personal allowance. If you can, top this up with money from your Isa or other savings.
The tax-free lump sum
The 25 per cent of your pot that you can take tax-free from age 55 (57 from 2028), is a popular perk, but it has long been rumoured that it could be on the chopping block.
Some savers are so worried that it will be scrapped or capped that they are taking the money early, and risking reducing their overall returns.
The Financial Conduct Authority (FCA), the City watchdog, said last week that £70.9 billion was withdrawn from pension pots that were accessed for the first time in the 2024-25 tax year, up 36 per cent from £52.2 billion the year before. Regular withdrawals from drawdown products — where you keep your pension money invested and withdraw an income as and when you need it — increased from £7.1 billion last year to £8.6 billion this year.
Karen and Glyn Woodland: “We feel as if the carpet is beingpulled from underneath our feet”
Glyn and Karen Woodland had not planned to withdraw their tax-free allowance, but now feel as though “the carpet has been taken from underneath” them.
The couple, from Shropshire, plan to withdraw about £100,000 from their pension pots before November’s budget. They have already taken some of their tax-free cash, but this portion had been earmarked for later life when the money could boost their state pension income or cover healthcare costs.
Karen, 62, who is retired after a career in financial services, said she felt betrayed after 40 years of saving. “It feels like I’m being forced to take it early. I put two thirds of my salary into that pension and worked so hard to not depend on the state. Now I feel like it’s something for nothing.”
The biggest frustration for Glyn, 65, who worked in logistics, is the Treasury’s lack of response to the rumours. “Reeves is letting speculation run rife. If she wants to stop it, she could just come out and say ‘look, I guarantee you I won’t be touching it’,” he said.
“You can’t help but think it’s stealth. Reeves has nowhere else to go, and we’re a cash cow.”
• We cannot afford generous pension rises as a matter of routine
Money has spoken to many savers making changes to their finances amid speculation over the budget. For some, the appointment of Bell as a key adviser was the final push.
John Harrow, 67, (not his real name), started to think about withdrawing from his pension fund six years ago when rumours over the tax-free lump sum began. He retired in 2017 and has since taken more than £130,000 from his pension pot, including £52,000 in the lead up to this year’s budget. Most of the money was put into Isas, using his and his wife’s £20,000-a-year allowances.
“I was on the verge of doing it anyway,” he said. “I think it’s a bit of a no-brainer for someone in my situation, as long as you have an equivalent tax shelter for the money to go in.”
If you already have plans to take your tax-free pension cash, then advisers say it makes sense to do it before the budget — it is unlikely that the tax backdrop is going to become more favourable.
But making such a move is not without risk. Philip Lewis from Evelyn Partners said: “Taking the cash too early or without careful consideration might end up coming back to bite you, tax-wise. It is best taken as part of a plan, with a picture of how your future years of retirement will be funded.”
On Thursday HMRC and the FCA warned savers that decisions to withdraw pension money were not necessarily covered by statutory 30-day cancellation rights, and that you could have to deal with the tax consequences — even if you were able to put the money back into your pot.
Lewis also warned that HMRC would be on the lookout for those trying to pay tax-free cash back into their pension. This would be considered “recycling” under the pension rules, which is not allowed.
The triple lock
The triple lock promise, which came into force in 2011, guarantees that the new state pension rises each year with inflation, earnings growth, or 2.5 per cent — whichever is highest.
• Pensioners are about to get the bill for the triple lock
Finding the money to fund this is a problem for the Treasury. According to its spending watchdog, the Office for Budget Responsibility (OBR), the cost of the triple lock is expected to reach £15.5 billion a year by 2029-30, three times the original estimate. But any loosening of the lock is considered politically unpalatable.
Reeves and Bell could decide to scrap the lock (he has previously described it as a “messy tool”), which would mean that state pension payments would not go up as much — something you would have to factor in when working out how far any private pension savings would stretch.
Income tax thresholds
The income levels at which you start paying the different rates of tax have not changed since April 2021 and will stay frozen until at least 2028. Many believe that Reeves will extend the freeze because it is such a big money maker: the OBR estimates that it will raise more than £38 billion in the 2029-30 tax year.
Frozen thresholds mean that more and more taxpayers pay more and more tax as pay increases and inflation push earners into higher tax brackets. Pensioners are not exempt — almost 9.2 million over-65s are expected to pay income tax in this tax year, up from 6.5 million a decade ago and three times as many as the 3.1 million who paid income tax in 1990, according to HMRC.
• Another 420,000 pensioners set to pay income tax this year
The Institute for Fiscal Studies found that pensioners are more likely to pay income tax than working-age people: 65.4 per cent of those aged 65 and over paid income tax in 2024, compared with 63.4 per cent of those aged 16 to 64.
As with any increase to income tax, it is worth ensuring that you are taking your pension income as efficiently as possible. And while the tax rules could change for the worse, remember that pensions are still the best way to save for retirement for most people.
Alex Shields from the advice firm The Private Office said: “Pensions have had a bit of bad press, but they will still be the most tax-efficient way to save for retirement, especially if you are a higher-rate taxpayer.
“If you can save into your pension as a higher-rate taxpayer and get 40 per cent relief, but become a basic-rate taxpayer in retirement so you pay 20 per cent tax, you’re winning.”
Your inheritance
It is almost guaranteed that most pensions will be included as part of your estate for inheritance tax purposes from April 2027 — the policy was announced in October’s budget and although unpopular, it seems inevitable.
The change means that while it used to be financially savvy to “spend the rest” of your savings (leaving your pension until last because you could pass it on tax-free), this is no longer the case.
It’s worth speaking to a financial adviser about the best way to manage your inheritance tax liability. At the moment there are still generous gifting exemptions, such as the seven-year rule and the “regular gift out of surplus income” trick, which could allow you to pass on money tax-free, but it’s important to balance this with keeping enough in your pension pot to fund your retirement and any potential care costs.