Autumn Budget: how might the government change pensions?

The government has now delivered its 2025 Budget including proposed changes to reduce the tax advantage of sacrificing salary to make pension contributions.

Beyond that, many of the rumoured tax-raising changes to pension rules failed to materialise, to the relief of pension savers. 

Here we round-up today's changes to the pension system. 

Salary sacrifice

Salary sacrifice is where you agree with your employer to give up some pay in exchange for a non-cash benefit. That’s most often a contribution to a workplace pension but could also include other benefits such as a company car or Cycle to Work scheme.

This reduces the taxable element of your income so you pay less income tax and National Insurance (NI). Your employer also saves NI and some offer to pass on some or all of that benefit to employees as extra pension contribution.

Salary sacrifice is often utilised by those seeking to bring their income below a threshold in the tax  benefits system that would otherwise be costly to cross. For example, higher earners may seek to bring their income below the £100,000 threshold above which they begin to lose their personal allowance - creating an effective 60% tax rate for earnings above this level.

These arrangements may now become marginally less generous because the Budget included measures to cap, from April 2029, the maximum amount of your salary you can sacrifice in favour of pension contributions without incurring NI to £2,000 per year.

Once the change comes into force, any pension contributions above that £2,000 cap will incur both employee and employer National Insurance contributions. The effect of this will depend on your personal circumstances. 

For example, someone earning £120,000 and putting £20,000 into their pension via salary sacrifice would face paying NI on £18,000 - the excess above the £2,000 cap. That would mean an extra NI bill of £360 for the employee and £2,700 for the employer at current rates.

Tax-free cash

The speculation that the Budget could bring significant reforms to tax-free cash from pensions ultimately came to nothing.

Rules governing the ‘Pension Commencement Lump Sum’ - the technical name for pension tax-free cash - allow for 25% of pension money to be accessed without tax to pay, up to a limit of £268,275. This can happen from age 55 (rising to 57 in 2028). 

There had been fears this ‘tax-free cash’ - could be limited to £100,000 and Treasury ministers were reported as considering the plan. The speculation - alongside the earlier announcement to include pension money in estate for Inheritance Tax (see below) - has contributed to a sharp increase in people accessing their tax-free cash. 

•    Read: How to make the right decision on taking pension tax-free cash
•    Read: Don’t cash your pension lump sum until you’ve read this
•    Read: 5 good reasons to take your tax-free cash - and 5 bad ones

Pension tax relief

Money contributed to a pension can benefit from tax relief. Basic rate tax relief is added automatically, meaning an £80 contribution becomes £100 inside a pension, while extra relief is available for higher and additional rate taxpayers which can be claimed back through their tax return. Income tax then potentially applies on withdrawals.
It means the biggest benefits are often available to those earning at higher levels and then withdrawing at lower ones.

•    Read more: How quickly will UK pension ages rise?

There has long been talk that the system could be changed to target the benefits of tax relief more to those on lower earnings. Previously Rachel Reeves, the Chancellor of the Exchequer, has argued in favour of a flat rate of 33% relief for everyone although the government has insisted that this is not its policy, and no longer Ms Reeves’ view. The Budget brought no change here.

A Pensions Commission - a gateway to bigger changes?

Officials have previously announced that a Pensions Commission will be established - or rather resurrected - to come up with ways to combat faltering retirement income provision in the UK. They have pointed to troubling forecasts which suggest people retiring in 2050 - those in their forties now - will have private pension income 8% lower than their counterparts today.

The plans echo an earlier Pensions Commission - established in 2002 - which had the same brief of tackling insufficient retirement saving. That first Commission eventually established ‘auto-enrolment’ - the system whereby eligible workers are automatically enrolled into workplace pensions, which has resulted in millions more workers saving something for their retirement.

There are many possible areas for the Commission to focus on, but top of the to-do list is updating rules for auto-enrolment. Right now, eligible employees automatically begin saving into a pension provided by their employer, with a minimum total contribution of 8% of qualifying earnings, with at least 3% coming from the employer. 

Those rates were set so as not to encourage people to opt-out of their pension - but they are unlikely to be sufficient to meet expectations of retirement income in the future. The Commission will decide whether higher rates should now apply.

In announcing its work, the Commission also pointed to specific groups - the self-employed, the young, members of some ethnic groups - who were facing higher shortfalls in their saving. The eligibility rules of auto-enrolment could be expanded to better cover these groups.

State Pension Age - will you wait longer for yours?

As well as the new Pensions Commission, the government is also reviewing the State Pension Age - the age at which you are eligible to claim the payment.

As it stands, the State Pension Age is 66 for both men and women. It is scheduled to increase to 67 between 2026 and 2028 and will steadily rise to 68 between 2044 and 2046.

The government is required to conduct a review into the state pension age every six years. The last one concluded in 2023, and the newly announced review is due to finish in 2029. The last review mooted a possible rise to 69 in 2046-48.

The review will consider the expected cost of the State Pension, and changes in life expectancy. The long-term trend of people living longer has prompted increases in the State Pension Age. However, that trend has faltered with life expectancy dipping slightly in recent years.

The ‘Triple Lock’ - unaffordable?

First introduced in 2011, the Triple Lock is the promise to raise the State Pension each year by the highest of either inflation, wage increases or 2.5%. The Triple Lock guarantees that increases in the State Pension will never lag any of these measures - not just over extended periods but in each and every individual year as well.

•    Read more: Triple Lock - what will the State Pension be in the future?

Its effect has been dramatic. The full State Pension is set to rise to £241.30 a week, or £12,548 a year, for the 2026/27 tax year after a 4.8% rise. That was the average relevant wage rise in the year before. Consider that as recently as the 2022/23 tax year the State Pension was just £185.15 a week - meaning it has risen more than 30% in four years.

That also makes it very costly, and two recent reports by economic think-tanks have suggested the payment will be unaffordable within 10 years. Both Labour and the Conservative parties promised, however, to retain the Triple Lock in this parliament ahead of the 2024 election.

Tax on inherited pensions

Plans announced in the 2024 Budget will mean pensions are included in estates for inheritance tax (IHT) purposes from April 2027. While a majority of people won’t be affected, the change could upend the finances of those who are.

Under the current rules, pension money falls outside of a person’s estate for inheritance tax purposes and can therefore be passed to beneficiaries without IHT applying. If death occurs before age 75 then no tax applies, and if after age 75 then the beneficiary pays income tax at their own marginal rate.

•    Read more on the new ‘double taxation’ on inherited pensions

This has led some people to organise their retirement finances in a way that preserves money held in pensions so that it could be passed on free of IHT. It has made sense for them to use money from other sources in retirement - including ISAs or other savings - before turning to pensions. 

The upcoming change - which is the subject of lobbying from the retirement industry - would require a big rethink for those preserving money in pensions for this purpose.

• Read: How 4% inflation could derail your retirement 
• Read: The '£299,325' cost of matching the State Pension
• Read: What income might I get from a £250,000 pension? 

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Eligibility to invest in an ISA or SIPP and tax treatment depends on personal circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). Select 50 is not a personal recommendation to buy funds. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.