by Jonathan Eida, researcher
Speculation ahead of the next Budget has reached new heights, fuelled by the Chancellor’s hints at potential tax rises. With fiscal pressures mounting and public finances stretched, speculation is once again turning to pensions.
The Autumn Budget 2024 marked a turning point in the government’s approach to pension taxation. One of the most notable measures announced was the plan to include unused pension funds and death benefits within taxable estates for Inheritance Tax purposes from April 2027. Until now, most pension pots have been excluded from IHT, allowing savers to pass on remaining funds to beneficiaries with significant tax advantages. Bringing these assets into the scope of IHT represents a major shift and effectively reduces one of the most valuable long-term benefits associated with pension saving.
While the reform may generate additional tax revenue, it risks discouraging saving at a time when individuals are already struggling to secure financial stability in retirement.
Recent data shows that savers are not waiting for the changes to take effect before acting. In 2024-25, a record £70.9 billion was withdrawn from private pensions, almost £20 billion more than the previous year, representing a 36 per cent increase. Defined benefit to defined contribution transfers continued to fall, from 7,181 to 6,418, suggesting a continued decline in appetite for moving legacy pensions. Yet the most revealing trend lies in draw down activity. Between April and September 2024, 168,000 pension pots entered draw down, rising a further 9 per cent in the following six months. Within this overall figure, larger pots worth £250,000 or more surged by 33.5 per cent. It seems clear that those with the most to lose from future tax changes are moving fastest to access their funds under the current regime.
At the same time, another area of potential reform may also be in line for a change: salary sacrifice for pensions. Salary sacrifice allows employees to exchange part of their salary for an equivalent employer pension contribution, bringing both income tax and National Insurance benefits. The Society of Pension Professionals (SPP) has warned in its recent report that this arrangement could become a target for reform in the search for new revenue. The SPP highlights that such a move could undermine one of the most effective mechanisms for encouraging consistent pension saving.
As the debate intensifies, it is worth revisiting why pension reliefs exist in the first place. Their purpose is to encourage saving and to prevent pensioner poverty, ultimately reducing long-term pressure on the welfare system. Welfare spending already accounts for the largest share of annually managed expenditure, forecast to reach £313 billion in 2024-25. Restricting pension incentives could, over time, shift more responsibility back to the state, increasing rather than easing the strain on public finances. It has nothing to do with tax avoidance, as Rachel Reeves may try and claim if she introduces this cap. While any pension contributions made through a salary sacrifice scheme will not be charged income tax or national insurance at the point they are paid in, at the point that the pension is drawn down, that income will be subject to tax.
As the next Budget approaches, the challenge for policymakers will be to balance fiscal necessity with long-term sustainability. Short-term revenue measures may offer temporary relief, but preserving confidence in the pension system remains essential. A sustainable economy depends on enabling people to save for retirement and reducing future dependence on welfare.