In the three months since Keir Starmer’s government was formed, a lot has been announced on the topic of pensions.
In July, chancellor Rachel Reeves promised a “big bang of reforms to unlock growth”, launching the first stage of a government review on the pensions landscape. Then, just before the summer recess, Reeves announced plans to axe the Winter Fuel Payment for all but the poorest pensioners, prompting a big conversation about Pension Credit.
With the Budget now fast approaching, could retirement taxes be the next focus area for the chancellor?
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Reports this week suggest Reeves has ruled out cutting pension tax relief for higher earners, amid fears this would be difficult to implement and risk upsetting public sector employees. However, it looks like she could still consider cutting the amount of tax-free cash savers are allowed to withdraw from their pension pot once they retire.
We take a closer look at what’s been announced and what else we could see in the Budget on 30 October.
Labour’s pension review
Labour unveiled a Pension Schemes Bill in the King’s Speech in July, with further information following from Reeves shortly afterwards. The chancellor promised a “landmark pensions review” to “boost growth and make every part of Britain better off”.
The review will come in two parts, with the first phase focusing on investment and the second focusing on retirement adequacy.
Highlighting the scale of the review, the government said: “[The] new Pensions Bill confirmed in King’s Speech could boost pension pots by over £11,000, with further consolidation and broader investment strategies to potentially deliver higher returns for pensions.”
It added that “an investment shift in defined contribution schemes could deliver £8 billion of new productive investment into the UK economy.”
The government also plans to take action to “unleash the full investment might of the £360 billion Local Government Pension Scheme to make it an engine for UK growth,” it has said.
UK equity markets have suffered chronic outflows in recent years while retirement costs have soared, leaving the average saver at risk of running out of money in old age. By boosting pension investment and directing funds into UK businesses, the government hopes it can address both challenges at once.
Addressing pension shortfall in defined contribution schemes
Most savers paying into their workplace pension today will be part of a ‘defined contribution’ (DC) scheme. While DC pensions are now the norm, they leave savers at greater risk of pension shortfall than the older ‘defined benefit’ (DB) model.
As a result, there is currently a “big intergenerational gap between those with adequate DB pensions and younger generations on course for inadequate DC pension incomes,” says Calum Cooper, a pensions expert at the consultancy Hymans Robertson.
With this in mind, DC reforms are an important area of focus in the government’s pensions review. The government claims DC schemes will be responsible for around £800 billion by the end of the decade, and it wants this money to be invested more productively.
It says: “Even a 1 percentage point shift of assets into productive investments could mean £8 billion of new productive investment to grow the economy and build vital infrastructure by the end of the decade.”
Going forward, we could see efforts to channel these funds into UK equities, private assets and growth companies.
Adrian Lowery, financial analyst at the wealth manager Evelyn Partners, says: “It sounds like the plan is to go further than Jeremy Hunt's Mansion House Compact, a voluntary commitment by some of the largest UK workplace schemes to allocate at least 5% into unquoted, UK growth companies by 2030.”
Pension consolidation: cutting down on “fragmentation and waste”
The government has also announced it will look at consolidating the Local Government Pension Scheme to “cut down on fragmentation and waste”. This defined benefit scheme is currently split across 87 funds and spends around £2 billion a year on fees and costs.
As well as reducing costs, pooling the money could allow the scheme to invest in a wider range of UK assets. These reforms could benefit 6.6 million public sector workers, many of whom are low-paid women.
As well as focusing on the Local Government Pension Scheme, the government is planning to address DB consolidation more broadly through its Pension Schemes Bill. In particular, it hopes to reduce complexity in the DB market through the use of “superfunds”.
A superfund exists when several defined benefit schemes are consolidated into one larger scheme. This allows employers to offload their defined benefit pension liabilities, which can help them manage risks and costs.
The government says consolidation offers “greater protection for members”, reducing the risk of them losing part of their pension if their employer becomes insolvent. By generating economies of scale, larger schemes also have the potential to invest in a broader range of investment strategies, such as high-growth assets.
Small pension pot problem
Through its Pension Schemes Bill, the government also hopes to address the problem of small pots. It plans to consolidate these in one place to prevent people from losing track of their money.
This should reduce admin for savers. Most people change jobs several times over the course of their lifetime, and as many as one in five savers think they could have lost track of a pension. This amounts to a staggering £50 billion in lost pension savings, according to analysis from the Centre for Economics and Business Research.
The previous government proposed “pot-for-life” reforms to help tackle the issue of lost pots. The Pension Schemes Bill from the new Labour government could help further these discussions.
As well as benefiting savers, the government adds that this measure will help pension schemes cut costs. Under current measures, schemes are required to manage a substantial number of loss-making pots. This has undermined their ability to invest in improving their offering for savers.
Consolidation could also help savers “reduce the fees they pay”, says Becky O’Connor, director of public affairs at PensionBee. Recent research shows that half of pension savers have no idea they are being charged fees – but over the course of a lifetime, uncompetitive fee structures could cost you dearly.
Better options for savers once they reach retirement
The Pension Schemes Bill will also require schemes to offer better options to savers once they reach retirement age. The government wants to ensure savers have a proper pension and “not just a savings pot when they stop work”, it says.
To help tackle this, schemes will be required to offer members “a retirement income solution or range of solutions, including default investment options”. We don’t yet know exactly what this will look like, but current retirement approaches include buying an annuity, putting your pension pot into drawdown, or a combination of the two.
“With the growing dominance of defined contribution pension schemes and the freedoms they offer, people’s strategies for taking income from their pensions are now of paramount importance,” says Kirsty Anderson, retirement specialist at the wealth manager Quilter.
“Decumulating from a pension can be treacherous, particularly without expert help, and savers can easily see their retirement pots run dry before they pass away,” she adds.
Upcoming Budget: will Labour change the way pensions are taxed?
Pensioners can sleep easy in the knowledge that the state pension triple lock is safe for now, after it featured in the Labour manifesto. Starmer reiterated this promise in September when he rejected pleas for a U-turn on the decision to means test the Winter Fuel Payment. The state pension is expected to rise by around £460 a year from 1 April 2025, and it is possible Reeves will use the Budget to confirm this point.
Private pensions could however come under the radar. Some savers are worried that the government could reduce or scrap the tax-free cash savers are entitled to when withdrawing money from a pension. Under current rules, you can withdraw 25% of your nest-egg before tax is due, up to a limit of £268,275. But, according to a Telegraph report, government officials are looking at recommendations by two major think tanks to reduce the limit to £100,000.
The good news is that cuts to pension tax relief seem to have been shelved for now, though. Under current rules, savers are entitled to tax relief on pension contributions, received at their marginal rate. Some were speculating that Reeves could cut this for higher earners by introducing a flat rate of relief, say 30%. However, this now looks unlikely, after senior Treasury officials reportedly told the chancellor the policy would hit public sector workers on “relatively modest incomes” (The Times).
Finally, inheritance tax reforms could appear in the Budget, potentially impacting pension savings. Pension pots currently sit outside of the inheritance tax net, making them a tax-efficient way to pass on wealth to loved ones. But think tanks including the Institute for Fiscal Studies have previously criticised this loophole.
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