Growing evidence is suggesting pensioners with larger defined contribution pension pots are starting to run them down much faster – or use them up in full – in a bid to reduce potential inheritance tax (IHT) liabilities.

From April 2027, unspent defined contribution pension pots will be added to the value of the estate when inheritance tax is worked out. Likewise certain defined benefit death benefits such as ‘death in deferment’ lump sums. The changes were announced in the 2024 Budget.

The government estimates the move will bring around 10,000 estates each year into paying inheritance tax for the first time as well as increasing IHT bills for a further 40,000 estates.

But the long gap between the announcement of the change and it being implemented has given wealthy pension savers and their financial advisers time to put in place a range of strategies to offset the impact of the move.

This impact is most likely to be seen with larger pot sizes where the inheritance tax risk is greatest.

Steve Webb, partner at pension consultants LCP and a former pensions minister, said: “For many years, one of the attractions of defined contribution pensions has been their favourable treatment under inheritance tax rules, especially for those with larger pots.

“But the 2024 Budget announcement has changed things, and people with larger pots are now exploring a range of strategies to reduce any potential IHT bill for their heirs.”

What are pension savers doing to avoid inheritance tax?

Pension savers are increasingly turning to two financial products – annuities and whole of life insurance policies – to help them overcome the fact pensions will be subject to inheritance tax from April 2027, Webb says.

Annuities

Annuities allow savers to convert some or all of their defined contribution pot into a lifetime income stream. This income can be potentially gifted using the “normal expenditure from income” exemption.

Provided the rules are followed, these gifts can immediately be exempt from IHT.

If a joint life annuity is bought, then this carries on after the death of the first person. This is free from inheritance tax for the second life, even if the couple aren’t married or in a civil partnership.

There has recently been a surge in annuity purchases bought with larger pension pots. Sales of annuities over £250,000 rose by 31% year-on-year in 2025, and sales of annuities valued at over £500,000 rose by 54%, according to data from the Association of British Insurers (ABI).

In the case of an annuity, those in poorer health will generally get a better rate, as the annuity will pay out for a shorter period.

Whole of life policies

With ‘whole of life’ insurance policies, savers can pay for regular premiums for a policy which pays out a guaranteed lump sum when the saver dies. These payouts are free of inheritance tax, provided the policy is set up under a trust.

Alternatively, this lump sum could pay for any inheritance tax bill.

In the case of a couple, the policy can be set up to pay out on the ‘second’ death, meaning that it pays out only at the point the estate passes between generations. This reduces the cost of the policy. Doing it this way is known as a ‘joint life, second death’ policy, and typically applies for deaths up to age 90.

Industry sources suggest a surge in demand for whole of life policies, with an increase of 92% year on year reported in Spring 2025.

The terms for whole of life policies will generally be better for those in good health, because the premiums will run for longer and the expected payout date will be later.

Webb said: “Defined contribution pension providers can expect to see changing behaviour amongst savers with the largest pots, with more interest in drawing down more rapidly for gifting or purchase of a whole-of-life policy, or even using the whole pot for annuity purchase. Providers may find that the largest pots disappear the quickest post-retirement.”

Annuity or whole of life policy – which is best to avoid inheritance tax?

Financial advisers will be able to recommend the right strategy for each individual, but according to Webb, factors which pension savers are likely to consider if deciding between an annuity or a whole of life policy include:

Timing: With the annuity option, the pension saver is ‘giving while living’ – passing on regular income immediately to heirs. By comparison, a ‘whole of life’ policy delivers a lump sum on death.

Health: Those in poor health could potentially get favourable annuity terms, though risk giving up their capital for a relatively limited payout period. Meanwhile those in good health could get favourable terms from a whole of life policy, especially one which only paid out on the ‘second death’ in a couple.

Adjusting for inflation: Whole of life premiums can be fixed in cash terms, providing assurance the policyholder can keep up the payments for life, or can be set to increase, thereby helping to maintain the real value of the eventual payout.

With both a whole of life policy and an annuity, the policyholder will need to keep records so their heirs can demonstrate ‘where the money went’ while the saver was alive, to ensure HMRC do not attempt to add the money gifted (or spent on premiums) back into the estate after death.

Clare Moffat, pensions and tax expert at Royal London, said: “It is clear that there is growing interest for clients who might be affected by IHT in financial products such as annuities or whole of life policies. But the options are complex and it may be worth an inheritance tax bill if that makes family members better off.

“Most people would benefit from taking professional financial advice so they can work out the best course of action for their specific circumstances.”

We look at how to navigate the inheritance tax paperwork maze in nine clear steps in a separate article.

Pension savers keen to squeeze the most into their retirement savings have a few weeks left to take full advantage of all of the (increasingly rare) pension perks HMRC allows in the current tax year.

With income tax allowances frozen, and almost everyone paying more in tax as each year goes by, pension saving is one of the few ways to keep more of earned income and build wealth.

The current 2025/26 tax year ends on 5 April, resetting several allowances. Before then, savers and investors who can are wise to make the most of the available ways to shelter money from the taxman and boost their pension savings.

Mike Ambery, retirement savings director at Standard Life said: “There’s still a lot you can do to make the most of your pension allowance. Pensions are one of the most powerful long-term savings tools, and making full use of them can help ensure you don’t pay more tax than necessary and keep more of your income working for you.”

1. Work out (and use up) your pension annual allowance

An obvious one, but putting as much as you can into your pension each year is a big winner when it comes to boosting your eventual retirement income. The end of the current tax year is a good time to work out how much you have already paid in and how much more you could pay in – which can be tricky.

For most people, the maximum you can put into your pension each year and still get tax relief is the pension annual allowance. It is £60,000 or 100% or your relevant earnings, whichever is less. This includes contributions from you, your employer and third parties. Relevant earnings include all earned income but not pension income, dividends or most rental income.

But higher earners may have a tapered allowance, reducing to as little as £10,000 if adjusted income exceeds £260,000. While they may also be able to carry forward unused allowances from the previous three tax years, those caught up in these numbers should seek advice.

Emma Sterland, chief financial planning officer at wealth manager Evelyn Partners, explained: “If you think you’re subject to the taper but would like to maximise pension contributions for the tax year, then you really should speak to a financial planner because the calculations for adjusted and threshold incomes can be very involved – as can the possible steps to remain the ‘right side’ of such thresholds.”

Also if you’ve already accessed your pension, it’s important to be aware that the Money Purchase Annual Allowance (MPAA) may apply instead of your pension annual allowance, reducing the amount you can contribute to a pension to £10,000 a year while still receiving tax benefits.

Ambery said: “This is triggered when someone begins taking taxable income from their pension, so it’s good to know which allowance applies to you.”

2. Pay up to £220k into your pension using ‘carry forward’

Savers who are set to maximise their current year’s pension allowance and have money on the sidelines they want to put to good use – maybe you got an inheritance this tax year – can take advantage of what’s known as ‘carry forward’ rules.

This is where you can go back and use up any unused annual pension allowances from the three previous tax years.

Sterland, at Evelyn Partners, explained: “The annual allowance is £60,000 for 2025/26 and was the same in the previous two years, but for 2022/23 it was £40,000. That affords a theoretical maximum contribution of £220,000 that can be paid into a pension in this tax year for those entitled to four years of the full annual allowance, and whose relevant earnings in this tax year allow it.”

The end of the tax year is the perfect time to review your use of carry forward. But there are some rules and restrictions to be aware of:

• You must have first used up the current year’s allowance – so the first step is to get an accurate reading of this year’s contributions and take those to the limit.
• You will need to have had a pension in each of the three previous tax years but you don’t need to have made any contributions and your new contributions do not have to be made into the same pension.
• Once the current year allowance is fully utilised, allowances from the ‘oldest year’ of the previous three are used up first and at the end of every tax year, the oldest year falls away. Therefore, any allowances not used from the oldest year – now 2021/22 – will be lost for good if they are not carried forward.
• To get tax relief on pension contributions that you make yourself, you need to ensure that the payments made in any tax year do not exceed relevant earnings in that year. An employer is not restricted by an individual’s earnings so they are able to pay in higher sums.

Sterland said: “Savers who have a large lump sum via a windfall like an inheritance might be looking to boost their pension by a maximum amount using up carry forward allowances before 5 April.

“But they need to be aware that that maximum will be limited by their relevant earnings in this tax year. Remembering that salary sacrifice pension contributions or other benefits taken by salary sacrifice will reduce relevant earnings, which could be an issue if someone wanted to make a big personal lump sum contribution using carry forward allowances.”

3. Make sure you are getting all the tax relief you should

The big draw to pensions are the tax savings – known as tax relief. Contributions are made from pre-tax income, so this effectively turns an £80 contribution into £100 for basic-rate taxpayers.

Higher and additional rate taxpayers can get further tax relief, making pension contributions even more attractive. They may need to claim it back via self-assessment. It means they could get a further £20 and £25 respectively on their tax returns, and this money can go into the pension too.

Ambery, at Standard Life, said: “However, some people don’t need to claim anything because their scheme gives full tax relief through payroll, for example, via salary sacrifice or a ‘net pay’ arrangement, where contributions are taken before income tax is applied.

“It’s a good idea to check with your employer or pension provider to understand exactly how tax relief works in your specific scheme.”

4. Did you get an end of year bonus? Sacrifice some into your pension

Bonus season typically happens – for those lucky enough to get one – between December and March. For those expecting a bonus, redirecting some or all of it into your pension can be a highly efficient way to strengthen your retirement savings.

Ambery said: “Bonus sacrifice can result in savings on income tax and National Insurance, making it a smart way to keep more of the value of your reward while giving your pension a meaningful boost. It’s a straightforward step that can help your money go further – just be sure to check that your total contributions remain within your annual allowance.”

Why you should consider acting now

Higher and additional rate pension tax relief had been, thankfully, the cat with nine lives when it came to chancellors seeking opportunities for raising extra revenue at recent Budgets.

“But the pressure on the UK’s public finances is not going away, so who knows what could happen to the higher rates of pension tax relief, or to the recently-expanded £60,000 annual allowance, in the next few years?” said Evelyn Partners’ Sterland.

“While the annual allowance for pension contributions is not quite "use-it-or-lose-it" in the same way – as previous years’ unused allowances might be available under "carry forward" rules – there’s no guarantee that either the higher annual allowance or carry forward will be around forever,” she added.

Pension savers are being encouraged to switch beneficiaries on their pension paperwork now to protect their retirement pot from inheritance tax for the next 16 months.

When someone starts saving into a pension they have to fill out certain forms. This includes a section on ‘beneficiary nomination’ – essentially telling the pension provider who should inherit their retirement pot when they die.

Many people fill in and forget this part of the paperwork and typically their current spouse is named as beneficiary. But looming policy changes to inheritance tax and pensions mean there is now a roughly 16-month window where pension beneficiary nominations really matter.

One financial advice firm told MoneyWeek it is currently flagging to clients they may want to temporarily change their pension beneficiaries in case they die before April 2027 when the stricter new rules come in and pensions become subject to inheritance tax.

Oliver Saiman, co-founder of wealth manager Six Degrees, said: “Some families may want to temporarily nominate their children – or any other longer-term intended heirs – as pension beneficiaries now, with a view to switching nominations back to a spouse once the new regime starts in April 2027.”

Avoiding inheritance tax on pensions

The guidance comes as new rules mean from 6 April 2027 unused pension funds are due to be brought into an individual’s estate and potentially subject to inheritance tax at 40%. Until then, pensions still sit outside the inheritance tax net.

By changing the nominated beneficiary to your children – or other heirs beyond your spouse – if death occurs before April 2027, the pension can pass outside the estate free of inheritance tax to the next generation.

After April 2027, you can change the nomination form back, often to benefit a spouse, allowing the survivor to access the pension flexibly under the new rules. Spouses inherit free of inheritance tax in any case.

“No assets move and no irrevocable decisions are made – it’s an administrative change that can be reversed at any time – but the timing could materially affect outcomes for some families,” said Six Degrees’ Saiman.

“While investors and families are going through their ’spring clean’ of their personal finances we find that pension beneficiaries is an area that can be overlooked,” he added.

How to save on inheritance tax

Saiman gave the example of a married individual who has a pension of £1 million.

“Normally, if the pension holder dies, it passes to the spouse free of inheritance tax due to the married couples exemption. However, it then forms part of the spouse’s estate on their death, meaning IHT is ultimately paid when the surviving spouse dies (assuming that takes place after April 2027),” he pointed out.

But by temporarily nominating a child – or if there are no children, any one else you would like to inherit – before April 2027, the pension can pass directly out of the estate if the holder dies before that date.

Saiman said: “This avoids IHT on the pension entirely. Before 6 April 2027 when the new rules come into effect, you could revert the nomination back to the spouse, so they retain flexible access to the pension.”

Without the temporary change: £1 million passes to the spouse and is included in their estate, meaning an IHT bill of potentially £400,000 later.

But with the temporary alternative person nomination, £1 million passes outside the estate on death, so there is no inheritance tax on the pension.

“This is purely an administrative change, but the timing can make a substantial difference in some families,” said Saiman, adding “clearly this is applicable only if the remaining spouse is not reliant on the deceased’s pension”.

Family circumstances can change, for example due to death, divorce or remarriage, so it is always a good idea to check your nominated beneficiary is up to date.

How to change your nominated pension beneficiary

Changing pension beneficiaries is usually straightforward – most providers allow you to update nominations online or via a simple form.

The change doesn’t move any money. It just updates who receives the pension when you die. You can switch it back at any time.

To change your pension beneficiary, log in to your online pension account and find the ‘beneficiaries’ or ‘nominations’ section to update details.

Or call your provider to request a new ‘expression of wishes’ form, which you'll complete, sign, and return, noting that any new form replaces older ones.

Retirement income today is rarely generated from a single source. It is typically built from a combination of the state pension, workplace or personal pensions, and other assets, each playing a different role.

Understanding how these different pension and non-pension income streams work – and the risks attached to each – can help you approach retirement with clearer expectations, financial advisers say.

Middle-aged Brits are sleepwalking into retirement without a plan, and time is running out, a survey has warned. Retirement income options are not being considered by 73% of 45-60 year olds, according to the study by pension provider LV.

A third (33%) of respondents to the survey aged 45 to 60 said they are unaware of financial products or strategies available to help protect their retirement income or boost their pension savings.

Sue Allen, chartered financial planner at Chester Rose Financial Planning, said: “When you retire, one of the key questions is how you will take an income. Many people find they spend more at the start of retirement as they enjoy their newfound freedom and tick off bucket-list experiences.

“Once early retirement has passed, your spending may settle down, but you might also want to prepare for higher costs in your later years in case you need to pay for care. Setting out your retirement goals could help you understand how to create an income that suits your lifestyle at different points in time.”

We look at the different retirement income options – like the state pension, defined benefit pensions versus defined contribution pensions, workplace pension and SIPPs as well as annuities, cash savings accounts, ISAs and property rental income – and how they can work together to fund your later years.

State pension – a baseline income

The state pension provides a guaranteed, inflation-linked income for life and forms the baseline of retirement income for most people.

The full new state pension (for most post-2016 retirees) is now £230.25 per week for 2025/26, or £11,973 per year, while the full basic state pension (for those born before April 1953) is £176.45 weekly – amounting to £9,175.40 a year – both increased under the triple lock, with payments made every four weeks.

Eligibility and amounts depend heavily on National Insurance contributions, requiring 35 years for the full new state pension and around 30 for the basic. You can begin claiming the state pension at 66, but the state pension age is rising.

Jude Dawute, managing director at financial advice firm Benjamin House, said: “While it provides an important level of security, the state pension on its own is generally designed to meet basic living costs, rather than support a broader retirement lifestyle.”

Pensions UK, a trade body, estimates a single person household needs £13,400 a year post-tax income to cover the basics in retirement – excluding housing costs – so while most of this will be covered by the new state pension, some other savings or income will be needed besides.

We look at how much you need for a comfortable retirement in a separate article.

Defined benefit pensions – predictable income

Defined benefit (DB) pensions provide a pre-determined income for life, usually payable from a scheme’s normal retirement age (commonly 60 or 65). The income is not affected by market movements and continues for as long as you live. You can usually take 25% tax-free as a lump sum, with the rest of the income taxed at your marginal rate.

DB pensions are typically used to meet core, ongoing expenditure, because the income is known in advance and often includes inflation protection.

So if a person, aged 65, had a defined benefit pension paying £18,000 per year and gets the full new state pension of £11,973 per year, their total guaranteed retirement income would be £29,973 per year.

“This income would be paid regardless of investment conditions or how long the person lives, providing a stable base from which other retirement decisions could be made,” said Dawute.

Defined benefit pensions are usually inflexible regarding how income is taken and at what level. However, many allow a tax-free lump sum in exchange for lower income.

Allen, from Chester Rose Financial Planning, said: “The decision whether to take a tax-free lump sum or not needs careful consideration, as once taken, it cannot be reversed. In most cases, maximising guaranteed income is preferable unless the lump sum is genuinely required.”

Defined contribution pensions – flexibility and risk

Defined contribution pensions work differently to defined benefit pensions. Instead of providing a guaranteed income, they build up a pension pot, which can usually be accessed from age 55 (rising to 57), with no requirement to retire at a fixed age.

This flexibility allows income to be tailored to individual circumstances, but it also means retirees remain exposed to several risks.

“Unless funds are converted into guaranteed income – by buying an annuity – DC pensions remain invested. Their value can therefore rise or fall with markets,” Dawute said.

A key consideration is sequence risk, he pointed out. This is the impact of taking withdrawals during periods of poor market performance, particularly early in retirement.

Dawute said: “Losses at this stage can have a disproportionate effect on how long a pension pot lasts. Diversified portfolios can help manage volatility, but investment risk cannot be removed entirely.”

Consolidation, transfers and SIPPs

Many people reach retirement with multiple defined contribution pensions, built up over different jobs.

Consolidation brings these pensions together, often into a self-invested personal pension (SIPP) or a workplace pension scheme. This can make it easier to understand your overall retirement income, manage investments consistently, and plan withdrawals.

“In some cases, individuals may also explore pension transfers from older arrangements and defined benefit pensions into newer ones with greater flexibility,” said Dawute. But he added where protected benefits exist – like guaranteed income rates – these decisions require careful consideration.

Turning defined contribution pensions into income

Deciding how much to withdraw from your pension can seem like a balancing act and there are often many factors you need to consider.

Allen said: “For example, when you access your pension, you can usually take up to 25% as a tax-free lump sum. You might be tempted to withdraw the money to travel, renovate your home, or indulge your hobbies. However, withdrawing a lump sum at the start of retirement could affect your long-term finances.

“You don’t have to take a lump sum at the start of retirement to benefit from the tax-free money – you may spread it out over several withdrawals, for instance,” she said.

Option 1: Flexi-access drawdown – adaptable income with market exposure

Drawdown allows pension funds to remain invested while income is taken as needed. It is often used to support discretionary spending, such as travel or irregular expenses, and to keep funds accessible. You typically take your 25% tax-free cash upfront.

Drawdown income is not guaranteed and is exposed to:

• Market volatility
• Inflation risk if withdrawals rise faster than investment growth
• Longevity risk if withdrawals continue for longer than expected

When you are in drawdown the sequence of your investment returns is of vital importance. In the scenario shown below, which shows a retiree with a portfolio of £100,000, taking annual withdrawals of £5,000, their portfolio could be 22% worse off if they experienced losses in the first two years of retirement, compared to having these same losses in years four and five.

Source: Quilter. Table shows a 22% difference between portfolio 1 and portfolio 2 after five years

Option 2: UFPLS – simplicity and tax considerations

Uncrystallised funds pension lump sums (UFPLS) allow individuals to take payments directly from their pension, with 25% tax-free and 75% taxed as income each time, unlike flexi-access drawdown where the whole tax-free amount is usually taken upfront.

It's a way to get money bit-by-bit without setting up a full drawdown plan or triggering the money purchase annual allowance (MPAA) on the first withdrawal and allowing the rest of your fund to keep growing.

UFPLS is commonly used for:

• One-off expenses
• Early retirement bridging until the state pension or other retirement income kicks in
• Smaller pension pots

Dawute said: “Because each withdrawal is taxed, timing and frequency can significantly affect your overall tax position.”

Option 3: Annuities – guaranteed income and annuity risk

An annuity converts pension savings into a guaranteed income, usually payable for life.

People often use annuities to cover essential spending, reducing reliance on investment markets and removing the risk of outliving their savings.

“However, annuities involve annuity risk – once an annuity is purchased, the income is typically fixed based on market conditions at that time and cannot be changed later,” said Dawute.

Inflation risk and annuities:

• Level annuities start at a higher income but lose purchasing power over time
• Inflation-linked annuities protect real income but begin at a lower level. This reflects a trade-off between higher initial income and longer-term protection against rising prices.

Other sources of retirement income

Drawing income from a range of assets can help diversify risk and improve financial resilience in retirement.

Matt Finch, director of wealth management at Bentley Reid, pointed to some non-pension assets that can boost your retirement income:

ISAs

“ISAs offer highly tax-efficient income, with withdrawals, income and growth free from tax. In many cases, it can be advantageous to utilise taxable income first to maximise allowances before drawing on ISA wealth,” said Finch.

Cash

Cash savings can provide liquidity and short-term security, reducing the need to sell long-term investments during periods of market volatility, he said.

Rental property income

Finch said: “Rental income can continue to provide a steady income stream in retirement, although it remains taxable and carries ongoing management responsibilities, which should be considered in the context of lifestyle objectives.”

Part-time work

“Part-time or consultancy work can offer a phased transition into retirement, maintaining income and reducing reliance on pensions in the early years,” he added.

Combining pension income streams

The most effective retirement income plans combine guaranteed income, flexible withdrawals and long-term growth, according to the experts.

Chartered financial planner Sue Allen said: “They are built around spending needs, health and attitude to risk – and are reviewed regularly as circumstances and tax rules change. Retirement income planning is not about finding the perfect product. It is about structuring your money so it supports the life you want for as long as you need it.”

A 65-year-old with a full state pension, NHS pension, a SIPP valued at £400,000 and an ISA of £100,000, who is continuing to work until 67, could have a retirement income portfolio that looks something like the below, she said.

In early retirement, income is topped up from the SIPP and ISA to support higher spending. Once the state pension and NHS pension payments begin, reliance on the SIPP reduces.

Later in life, income needs decline further, and guaranteed income covers most spending, while modest withdrawals continue to provide flexibility.

“The aim is not to maximise income early on but to keep the income sustainable and tax-efficient,” Allen said.

Few people outside the Treasury understand how a Budget really comes together, or how the fiscal chess game inside Whitehall determines what happens to your tax bill, pension allowances, and savings returns.

One man familiar with the horse trading that goes on ahead of a Budget inside 1 Horse Guards Road, London – home of the UK Treasury – is David Gauke, a former chief secretary to the Treasury (2016-17), the second highest position in the department after the chancellor.

Now chair of Negotient, which advises on partnerships between the government and the private sector, Gauke, speaking exclusively to MoneyWeek, said while speculation about potential policy changes – such as will taxes rise – is playing out loudly in public, the story of this Budget will be in what happens behind closed doors.

“Budgets aren’t invented in a week,” Gauke said, “they are the culmination of complex negotiations between departments, the Treasury, No10, and sectors that matter to the economy: from energy to finance to housing”.

A common mistake many organisations make is to approach the run-up to a Budget as simply a lobbying exercise: a one-way pitch for a particular tax cut or subsidy, said Gauke.

“The Treasury rarely responds well to that. What works is negotiation, a two-way process where both sides understand each other’s constraints and build something sustainable, together,” he added.

MoneyWeek asked the former Treasury insider what Britain could expect from chancellor Rachel Reeves’ second Budget, due on 26 November. He revealed a complex picture of competing priorities and unpalatable decisions.

What could be in the Autumn Budget?

Officials and ministers are – as we speak – weighing how to fill what the Office for Budget Responsibility calls a “fiscal black hole” without stifling investment. The trade-off between fiscal rules and political promises dominates every conversation. Departments want more; the Treasury wants restraint.

With an estimated shortfall ranging from £27 billion (according to analysts at KPMG) and £50 billion (says independent think tank the National Institute of Economic and Social Research), it’s not going to be an easy gap to plug.

“When the fiscal headroom is thin, the question becomes not what the chancellor wants to do, but what she can responsibly afford to do,” Gauke explained.

Each year, this process includes quiet discussions with industry groups and sector bodies whose proposals can shape how policy lands. “These talks rarely make headlines,” Gauke said, “but they decide whether a tax or spending measure works in practice or ends up being reversed.”

The chancellor is clearly going to need to raise a lot of additional revenue. But she also needs to be able to sell the measures to the country as a whole and her political party. This means Reeves will “need to show the richest are making a big contribution”, said Gauke.

Before any decision the key factors Reeves will consider, according to Gauke, are:

• How much revenue will be raised?
• What will the political reaction be?
• Can this be presented as fair, especially to Labour voters?
• Does this disincentivise enterprise and investment?

How might this pan out for workers, pension savers and homeowners? Potentially, said Gauke, something like this.

1. Income tax

"If the chancellor is going to need a very large sum of money, it is very hard to do that without using the big tax levers, the most likely of which will be income tax,” said Gauke.

That would do less economic harm than a series of smaller tax increases, he said, but will be a clear breach of a manifesto commitment not to raise income tax, National Insurance or VAT. Reeves also “needs to show the wealthy will pay a greater share”, Gauke said.

Putting a penny on the basic rate of income tax would cost more than £1 a day in extra tax for higher earners, according to analysis by investment platform AJ Bell. It could also raise almost £7 billion next year for the Treasury, according to HMRC estimates.

2. Property tax

Various property tax changes have been mooted, including replacing stamp duty with a national tax on the sale of homes worth more than £500,000 and introducing a form of mansion tax with a capital gains tax charge on homes that sell for more than £1.5 million.

Further reports in the Daily Telegraph have suggested the chancellor could introduce a regular 1% charge on homes worth above £2 million.

“A property tax must be tempting, in that our current council tax system fails to distinguish between a quite expensive property and a very expensive property,” said Gauke, adding the allure for is stronger as a property tax “is also simple to explain”.

3. Inheritance tax

Changes to inheritance tax are “also possible”, said Gauke, but the ongoing row about agricultural property relief and business property relief shows increasing inheritance tax revenue comes at a high political cost.

“Tightening the ability to make gifts outside the IHT regime, for example, will raise little by way of revenue but will provoke vocal opposition, including from those unlikely ever to be affected,” said Gauke.

“The Treasury might, however, think they need a row here to demonstrate that they are trying to raise revenue from those with greater assets.”

4. Pensions

Various Budget pension policy changes have been suggested, from reducing tax relief to cutting the amount of tax-free cash. In another life, Gauke was also work and pensions secretary (2017-2018), so he knows the struggles of pension reform.

Reducing the pension tax-free amount radically could be criticised as retrospective, he said – people invested in their pensions on the assumption they would get 25% tax free. But if the change is set for some future date, it will not raise substantial revenue for many years, Gauke pointed out.

Either way, constant speculation about changes to the pension tax-free amount “is damaging for our system and Reeves needs to end the uncertainty one way or another”, he said.

5. ISAs

Reeves is heavily tipped to cut the cash ISA allowance, down from its current level of £20,000 to somewhere between £10,000 and £4,000, to get Brits investing in UK companies instead.

“I expect they will go ahead with some reforms here,” said Gauke. “But I think it will get some pushback given this will reduce the tax-efficient options for people who will already have paid tax once on this money.”

Where could Reeves slip up?

Some of the measures Reeves will announce in her Budget will be more about a political message than the revenue raised, Gauke said. But he added “there are a couple of issues where she needs to be careful”.

1. Too much double (or triple) taxation

“Many of the options that appear to be under consideration may well involve the same people being hit multiple times, and that might mean very vocal opposition,” Gauke said.

2. Too hostile to the wealthy

Our tax system already relies heavily on the richest. If the government gives the impression of being hostile to the wealthy, there is a risk more of them will move elsewhere, or that people won't come to the UK in the first place, said Gauke. “When the government is hoping to get the economy growing, that is a bad message to send out."

Budget negotiations behind-closed-doors

Reeves has little room for giveaways – so how the Treasury negotiates with key sectors will determine the real-world effects on your personal finance balance sheet.

“Expect renewed talks with utilities as the government considers longer-term energy-price reform,” said Gauke. “A poorly structured deal could see bills spike again, feeding inflation and higher interest rates – bad news for mortgage rates and bond portfolios”.

Likewise if ministers revive home buyer incentives, the negotiation with lenders and developers will dictate whether that supports supply or merely pushes up house prices. “A well-designed deal could stabilise property values; a hasty one could reignite volatility,” said Gauke.

Examples of successful Budget compromises

Some of the most successful policies of recent years have been born of negotiation, not confrontation. A case in point was the single-use plastics tax, introduced after extensive talks between the Treasury, manufacturers, and environmental groups such as Greenpeace.

“That policy worked because environmental campaigners, business, and government found common ground,” Gauke explained. “Rather than imposing a blanket ban, the Treasury designed a tax that rewarded recycled content and supported investment in cleaner production.”

One of the clearest examples of Budget-era negotiation shaping personal finances came during the 2022 energy crisis. As wholesale gas prices surged, the Treasury, Ofgem, and energy suppliers negotiated the Energy Price Guarantee – a deal designed to shield households from soaring bills.

“It was the right instinct,” Gauke said. “But the negotiation focused on short-term relief rather than long-term resilience. A more creative, risk-sharing approach between government and suppliers could have produced greater stability and less inflationary pressure.

“And that matters, because inflation feeds directly into mortgage rates and the real value of savings.”

He also pointed to the Help to Buy scheme, which emerged from Treasury discussions with lenders and developers to boost market confidence after the financial crisis. “That showed what Treasury negotiation can achieve when the aim is to unlock credit and stimulate investment,” Gauke said.

It also, he added, illustrated the importance of balance, ensuring measures to support growth work alongside policies to increase supply. “Getting that right is exactly what the government faces again now,” he added.

“Whether it’s energy transition, housing, or pensions, the government will have to negotiate intelligently with the private sector,” Gauke said. “That’s how you deliver value for taxpayers while creating opportunities for investors.”

Industry experts are calling for significant reforms to the process through which inheritance tax will be applied to pensions, calling for a fairer and more humane approach to the reform.

Pensions are currently exempt from inheritance tax (IHT) calculations, meaning that the value of a pension does not apply to the nil-rate band or the total value of an estate that is taxed for IHT.

But chancellor Rachel Reeves announced in last year’s Autumn Budget that inheritance tax will apply to pensions from April 2027.

Former pensions minister, Steve Webb, is calling on the House of Lords to revise the planned process through which pensions are included in IHT calculations, and giving evidence today (3 November) to The House of Lords Economic Affairs Committee’s hearing on the Finance Bill and changes to IHT.

Webb, who is also a partner at consulting firm LCP, and Alasdair Mayes, head of pensions and tax at the firm, have written a joint statement calling on the inquiry to enact the changes which they argue will make the process “more effective, efficient and – frankly – humane”.

“The new regime will create a lot more work both for personal representatives dealing with estates and for pension schemes and providers,” said Webb. These complications could delay payments to both grieving families and the taxman.

“This is already a difficult time for families, and they will now face a ticking clock of six months before interest and penalties could apply if IHT is not sorted out.”

Bringing pensions into the purview of IHT is already controversial. Research from wealth manager Saltus revealed in October that a third of people are actively exploring strategies to protect their pension from IHT, while 30% are reviewing or adjusting their pension savings or retirement planning ahead of the change taking effect.

“The decision to bring pensions into scope from 2027 has really sharpened focus on long-term planning,” said Alex Pugh, financial planner at Saltus. Pugh added that many Saltus clients are asking questions about whether or not the tax rules could change again in the upcoming Budget.

But the team at LCP argue there are major wrinkles in the proposed system that need to be ironed out first.

What changes are being proposed to the pensions IHT process?

LCP’s proposal wants changes to be made that makes the process fair and efficient, and to serve its stated purpose of closing direct contribution (DC) pensions as a means of avoiding IHT. These include:

Excluding ‘death in deferment’ lump sums and funeral payments from the IHT net.

The justification for the policy of including pensions in IHT calculations is that DC pensions had been used by some as a vehicle to avoid IHT. But Webb highlights that the proposed changes go far beyond DC contributions and ‘death in deferment’ lump sum payments – the pensions of people who have left the company providing the plan and have died before starting to take their pension – as well as funeral grants out of pension schemes.

“Given that neither of these systems is being used to avoid IHT, it seems unfair to catch them in the scope of the policy,” said Webb.

Ensuring personal representatives aren’t unfairly exposed.

Under the framework as it currently stands, personal representatives will be liable for ensuring that IHT is paid, but in the case of pensions, they may not have direct control over some of the funds.

“One example would be a pension pot payable to a beneficiary who is not the personal representative,” said Webb.

Webb suggests that solutions to this problem could be to ensure representatives are only liable for IHT due on the rest of the estate, or giving them the power to require the pension provider to deduct IHT before paying out.

A fairer approach towards payment delays.

Representatives are responsible for ensuring IHT is paid within six months, and beneficiaries could be exposed to interest and penalties if this deadline is missed.

“But they may be penalised for matters beyond their control, such as delays in obtaining information about fund values and about other beneficiaries,” said Webb. “Ideally a longer deadline or at least waiving the penalties and interest would seem appropriate in such cases.”

Addressing potential payment delays.

Bringing pensions into the scope of IHT could lead to a delay in payments to legitimate beneficiaries.

“Under the new rules, it’s not clear assets can be paid until the whole process has been completed and the personal representative knows the value of all pension and non-pension assets and how these are to be split between exempt and non-exempt beneficiaries,” said Webb.

“This means that even a payout to a spouse – where no IHT can be due – could be put on hold for months. It would be better if such payouts could be released before IHT matters were resolved.”

Addressing delays in information.

“Given the time pressure on this whole process, more needs to be done to ensure that pension schemes become aware of the death of a member as soon as possible,” said Webb.

He proposes allowing the government’s ‘Tell us Once’ service to share information with pension providers, or requiring registrars to share data about deaths faster and more frequently.

LCP also proposes reducing the ‘end-to-end’ delay of the entire process by allowing probate applications to be processed in parallel with IHT assessments.

Help bereaved families track down pensions.

Finally, it could be difficult for bereaved families to track down pensions, which could further delay the process of assessing the estate.

“Once the new pensions dashboard is up and running it should be made available to bereaved families, and the data displayed should be expanded to include unspent pension balances,” said Webb. “This would be of great assistance to those trying to locate all of someone’s pensions following a death.”

Chancellor Rachel Reeves is no longer considering cutting the amount of tax-free cash retirees can take from their pension pots, according to reports.

Speculation that pension tax-free cash would be a target in the Budget has been swirling for some months. The Treasury had refused to be drawn on the issue, leaving pension savers nearing retirement worried they may miss out if they didn’t withdraw their 25% before the chancellor stands at the dispatch box on 26 November.

It was thought Reeves had been considering reducing the amount of tax-free cash pensioners can take at retirement to £100,000, following a recommendation by a Labour-aligned group, of which she is a member.

But the chancellor is now no longer entertaining the idea of further limiting the level of tax-free cash retirees can take from their pension, according to a report in the Telegraph citing confirmation from unnamed officials. Moneyweek has contacted the Treasury for comment.

Jamie Jenkins, director of policy at Royal London said: "Royal London has been among many across the industry calling for clarity on tax-free cash, so this is good news. This is undoubtedly one of the most popular and best understood features of pensions, and it was becoming a great source of anxiety among savers."

Most retirees can take 25% of their pension pot tax-free from age 55. But there is a limit – £268,275.

Pension tax rules have been described as currently “too generous and clearly unfair”, in a Fabian Society report which put forward the proposal to lower the limit on pension tax-free cash to £100,000. It said reforms are needed “to address the systematic under-taxing of pensions”, including tax relief.

Cutting tax-free pension cash is a “progressive” policy “that would raise revenue from wealthy older people who have pensions that were historically under-taxed”, the report said.

But its author Andrew Harrop, a former Fabian Society general secretary, admitted the move was unlikely to appear in the Budget due to pushback from critics.

“The chancellor knows the media backlash she could expect. Rich savers nearing retirement would argue that their big untaxed lump sum was part of the pension ‘deal’ on which they had based their plans,” the report said.

Pension tax-free cash withdrawals surged 61% last year in a Budget-related frenzy as over-55s started making a dash for their tax-free cash. However pension experts have been warning retirees not to rush in this time around only to regret their decision later, with wealth firm AJ Bell calculating a retiree could miss out on more than £63,000 in investment returns by taking the tax-free cash too soon. Worse still you could face a 55% tax charge for breaching pension ‘recycling’ rules.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “People may rush to take the money now in the belief that they can reinvest it back into their pension if the change does not happen. However, they risk falling foul of pension recycling rules that will land them with a nasty tax charge.”

What are pension recycling rules?

Some people will have a plan for their tax-free cash – for instance to pay off a mortgage or carry out home renovations. But there will be others who are taking it as a knee-jerk reaction to Budget speculation, and this comes with risks.

HMRC recently clarified that people would not be able to put in a request for their tax-free cash and then cancel it should an announcement not be made in the Budget.

Some people may think they can take the tax-free cash now and then if the change doesn’t happen, just reinvest it back into their pension.

“However, doing this could put you at risk of breaching pension recycling rules which could see you clobbered with a hefty fine of up to 55%,” said Morrissey.

Pension recycling is deemed to have happened when someone has taken their tax-free cash and recycled it into their pension for the purposes of receiving artificially high tax relief.

For pension recycling to have happened, all of the following conditions need to have been met:

• The individual receives tax-free cash from their pension.
• Because of this, the amount of contributions paid into the pension scheme is significantly greater than it otherwise would be. HMRC will look at contributions in the tax year the tax-free cash is taken and the two tax years either side to determine this.
• The additional contributions are made by the individual or by someone else, such as an employer.
• The recycling was pre-planned. This is something that HMRC needs to establish, and it can prove very tricky. This planning must have happened either before or at the time the tax-free cash was taken, not after.
• The amount of tax-free cash, taken together with any other such lump sums taken in the previous 12-month period, exceeds £7,500.
• The cumulative amount of the additional contributions exceeds 30% of the tax-free cash.

The pre-planning condition is the area that causes the most confusion, said Morrissey. “It has to be proven that you planned to use your tax-free cash either directly or indirectly to boost your pension contribution to get extra tax relief.”

An example here could be taking out a loan to pay the increased contribution and then using your tax-free cash to repay it. HMRC says that each case is to be decided on its own merits so it’s difficult to outline cases that would definitely result in HMRC saying pre-planning hadn’t taken place.

In theory people can continue funding their pension without needing to worry about falling foul of the recycling rules provided not all of the above conditions are met.

However, it’s extremely complex. “People should consider speaking to a financial adviser if they wish to continue contributing to their pension to make sure they don’t inadvertently break the rules,” said Morrissey.

Fears of further pension reforms in chancellor Rachel Reeves’s Autumn Budget are fuelling a surge in self-invested personal pension (SIPP) savers withdrawing their money, according to data from one of the UK’s largest investment platforms.

Bestinvest said its DIY pension savers made a third more (33%) demands for their money in September, compared to the previous two-year average.

This was largely driven by those aged 55 and over accessing their 25% tax-free cash lump sum, the investment platform said.

The size of the pension income withdrawals from SIPPs, known as a pot for life pension, also jumped in September – by 146% – compared to the two-year average for the same month in 2023 and 2024, as retirees cashed out.

Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, said: “Saving into a pension is a long-term financial goal that requires commitment from a saver but also a stable and consistent approach from the government.

“Incessant speculation around pension changes can have huge repercussions, as it can discourage savers from topping up their retirement pots at a time when they’re already being criticised for not contributing enough.”

Why are investors switching to ISAs?

Uncertainty around the taxing of pensions is seemingly already prompting fewer people to use the traditional retirement product to save for their golden years. Contributions into SIPPs slowed to increase by just 3% last month, Bestinvest reported.

Meanwhile ISA contributions rose by 38% in September compared to the previous two-year average for the same month on the online investment platform. The move is thought to reflect savers reconsidering their retirement saving habits now unused defined contribution pensions will come under the scope of inheritance tax from April 2027.

Though ISAs are also subject to inheritance tax, unlike pensions, they can be spent at any time.

Looking back over the three months to the end of September, SIPP contributions at Bestinvest are down by 24% compared to the previous two-year average for the same period as opposed to ISA contributions which rose by 10%.

We compare ISAs vs SIPPs in a separate article.

“Ultimately, both ISAs and pensions are valuable tools for those looking to build long-term, tax-efficient savings in the UK though they have different limitations,” said Haine.

“An ISA has a tax-free allowance of £20,000 that cannot be carried forward to the next financial year, but the money held within an ISA is not taxable when it is withdrawn.

“Pensions have a higher annual allowance (AA) and the benefit of carry forward rules where savers can backdate contributions, up to their AA, over the previous three financial years – useful for those who receive a windfall such as an inheritance or the sale of a business.

“But a pension is taxable at the withdrawal stage and will also become subject to IHT – like an ISA – in 18 months’ time.”

Cuts to tax-free cash

One of the biggest concerns centres on rumours the chancellor may reduce the maximum amount pension savers, aged 55 can over, can withdraw tax-free from their retirement pots. Currently savers can access 25% of their pension tax-free, up to a maximum of £268,275 – a ceiling introduced by former Conservative chancellor Jeremy Hunt.

Similar speculation ahead of last year’s Autumn Budget triggered a wave of withdrawals from pensions, with some savers later regretting their decision after realising they did not need the cash immediately, and no changes were made.

This year, rumours of further pension tax changes appear to be having a similar effect, compounded by the fact that pensions minister Torsten Bell had previously advocated reducing tax-free cash while running the Resolution Foundation, a think tank.

Potential changes to gifting rules

With pensions brought under the scope of inheritance tax (IHT) in the chancellor’s maiden fiscal statement last year, many DIY investors have radically changed their approach to pension saving – choosing to withdraw pension funds to spend or gift rather than risk their beneficiaries being hit with a heavy tax bill on their death.

Speculation around potential changes to gifting rules – including the possibility the seven-year rule may be extended, or a lifetime gifting cap introduced – is also driving the significant behavioural shift of more people withdrawing more from their pensions before the Budget to avoid inheritance tax.

Haine said: “At Bestinvest, we’ve seen a surge in tax-free cash requests as we edge closer to the Autumn Budget, echoing the trend seen ahead of the chancellor’s first fiscal statement last year.

“Taking tax-free cash prematurely as a knee-jerk reaction to a possible policy change can undermine retirement plans and prove to be tax inefficient. Moving a large sum out of a tax-protected wrapper, like a pension, into a taxable environment such as a bank or building society savings account can counteract the gain someone makes from making the tax-free withdrawal in the first place.

“From that point, interest, income or capital gains could be liable for tax unless the money falls within an existing tax-free allowance, such as the personal savings allowance, or is transferred into another tax-efficient vehicle such as an ISA.”

Can you reverse tax-free cash withdrawal?

Anyone considering taking large sums from their pension would be wise to take financial advice before they make any decisions. Worryingly, 70% of people do not, according to Financial Conduct Authority data from the 2024/25 tax year.

“Without a clear picture of their retirement funding strategy, they cannot assess whether accessing their tax-free pension lump sum now makes sense – or whether it’s better to leave the money invested for longer or only take a portion of the 25% tax-free element,” said Haine.

Decisions made in haste cannot always be reversed. While some providers previously allowed savers to cancel tax-free lump sum withdrawals within a certain cooling-off timeframe, HMRC and the FCA have recently made clear that providers should not permit savers to reverse their decision. This means once the money is taken, the decision cannot be undone.

Consider cutting tax-free cash and the annual allowance but U-turn on making pensions subject to inheritance tax – that is the advice to chancellor Rachel Reeves ahead of her Budget from a former pensions minister, Ros Altmann.

Pensions should be changed “as little as possible” in the upcoming Budget, set for 26 November, Altmann, who served as pension minister under David Cameron from May 2015 until July 2016, said.

But with Reeves facing a projected black hole of £30bn in her spending plans, and Labour’s pledge not to raise VAT, income tax or National Insurance, rumours have been circulating that pension savers are in the chancellor’s sights as a potential source of much needed revenue via Budget tax rises.

Altmann said: “Recent weeks have seen an almost non-stop flow of suggested pension policy reforms for the upcoming Budget. Because so much public money is spent on pensions, and many commentators believe money should be redistributed away from the old to the young, several radical ideas have been proposed.

“The chancellor should aim to change as little as possible in the near-term and avoid adding new complexities, while ideally encouraging more pension contributions to benefit British growth and investment.”

Altmann has weighed up the potential pension measures on the table.

Potential Budget pension reforms

1. Annual allowance – reduce from £60,000

One of the easiest ways to reduce the annual spending on tax relief for pensions, would be to lower the annual allowance, Altmann pointed out.

The annual allowance is a threshold which restricts the amount of pension savings you are allowed each year with tax relief to £60,000 a year. The total annual pension contribution cannot be greater than your earnings, so anyone on average earnings could not contribute anywhere near the annual limit.

“The chancellor might want to reduce this to, say, £50,000, saving some money spent on tax relief,” Altmann said.

2. Tapered annual allowance – reduce from £10,000

“The chancellor may be tempted, more for ideological ‘hit the rich’ reasons than to raise serious revenue, to reduce or even abolish the tapered pension annual allowance,” said Altmann.

The tapered annual allowance only applies to the very highest earners (earning over £200,000). Their permitted annual pension contributions reduce as their so-called ‘adjusted earnings’ increase from £200,000 to £260,000, reaching a reduced maximum of £10,000.

It would not save much money as there are relatively few top earners, Altmann suggested.

3. Money purchase annual allowance – reduce from £10,000

There is also the money purchase annual allowance, “which the chancellor may decide to reduce or even scrap altogether”, Altmann said.

The money purchase annual allowance (MPAA) is a £10,000 limit on annual pension contributions that receive tax relief for those who have already taken more than their tax-free cash out of their money purchase defined contribution pension.

Again, Altmann said this is unlikely to save much money as it only applies to a small proportion of people.

4. Limit pension allowance carry forward rules

The current system allows people who have already used their full annual allowance of £60,000 this year, to carry forward any unused annual allowance from the last three years as well.

The chancellor could decide to reduce the number of years that contributions can be carried forward, or even stop carry forward altogether for next year and save some tax relief that way. This would mostly hit the higher earners, but Altmann said would also not raise significant amounts of revenue.

Pros and cons of changing the pension annual allowances

Pros

• Easy to understand and not too complicated to administer
• Would not impact the majority of working people, as only the higher earners are likely to find their contributions restricted by these lower limits.
• Would save money in the first year and in future years

Cons

• High-paid defined benefit scheme members such as senior NHS staff would face large tax bills on their pension contributions, but introducing only for defined contribution and not defined benefit would anger higher earners in private sector

5. Cut tax-free cash

There have been strong rumours that the chancellor would like to reduce the amount of tax-free cash that people can take from their pensions. Currently, up to a quarter of most pension funds can be withdrawn tax-free and spent as you like. Unless you have a protected sum, the maximum amount of tax-free withdrawals is capped at £268,275. This could be reduced to, say, £50,000.

Pros and cons of reducing tax-free cash

Pros

Significant extra revenue for the chancellor, without hitting those with more modest pensions, so from a social equity perspective the government may find this tempting.

Cons

This change would particularly hit people relying on using their tax free lump sum to pay off a mortgage or other loans, who would now face a high tax bill to withdraw the money.

The rumours of this possible change have already caused huge amounts of money to be withdrawn from pensions, just in case the limit is lowered.

Altmann said: “Many of those taking money out now may regret this later if there is no change, while those not quite at age 55 – the minimum age that you can make such withdrawals – will be most upset if the change does happen.”

6. Impose National Insurance on pensions in payment

The chancellor could introduce a new National Insurance pension levy, perhaps at a 2% rate.

Altman said: “Average pensioner incomes in the UK are approximately £21,000 a year. Assuming say, eight million pensioners pay 2% on £9,000 of income – the amount above the personal allowance – they would each pay around £180 a year in new tax and the chancellor would receive about £1.4billion in extra revenue,” Altman calculated.

Pros and cons of imposing National Insurance on pensioners

Pros

• Chancellor receives significant extra revenue
• Higher taxes on pensioners would ‘level the playing field’ with working people.
• It could be portrayed as an issue of inter-generational fairness, which is a theme that has been very popular with this government.

Cons

• This would seem to break the government’s promise not to increase tax, NI or VAT, and would upset millions of pensioners.

7. Pension funds should use tax relief to invest in British companies or infrastructure and real assets

Altman’s proposal would be to require at least 25% of all new pension contributions to be invested in British assets – quoted companies, venture capital, start-up capital and real assets such as infrastructure, property and alternative energy.

“If pension funds want to put more than, say, 75% of their contributions in overseas assets, instead of here, they would not receive help from British taxpayers. It would be their choice. This is not mandation, it is a quid pro quo for receiving the taxpayer money,” Altmann said.

8. New tax on unused pensions that bypasses inheritance tax

Altmann has branded the chancellor’s decision last year to impose inheritance tax on unused pensions on death from April 2027 “a disastrous change”.

The Chancellor could instead, she said, consider introducing a new tax on unused pension benefits, administered completely outside the inheritance tax system, payable by the pension provider. This could be set at a level of 10%, 15% or 20%, but would apply to all unused pensions, regardless of whether the person’s estate pays inheritance tax.

“It would be a straightforward amount to collect and would raise extra revenue for the Chancellor,” Altmann said.

9. Make auto-enrolment compulsory at the minimum level – and scrap tax relief

Pros and cons

Pros

• Chancellor saves significant sums on tax relief
• With opt-out rates so low, most workers would be relatively little affected
• All workers would be treated the same, regardless of earnings, in respect of the minimum auto-enrolment levels and none would receive tax relief on their contributions. Currently, the lowest paid in net pay schemes get no tax relief and higher earners get more than those on basic rate tax.

Cons

• Could be seen as a new work tax
• Lower take-home pay
• Could add to employer cost pressures to increase contributions instead of workers

10. Scrap National Insurance relief and salary sacrifice

The cost of National Insurance relief is estimated to be around £20billion a year. Tax relief was designed to be deferred tax, which allows people to contribute to their pension without being taxed, but then they would pay tax on the pension they receive in retirement. However, allowing employers to claim National Insurance relief for the pension contributions they pay on behalf of staff, is “pure tax leakage”, Altmann said - because pensioners do not pay National Insurance on their pension income.

In addition, many employers use ‘salary sacrifice’ to pass on the savings in National Insurance to workers as well, giving an extra boost to their pension, at no additional cost.

A decision to ban the use of salary sacrifice and end employer National Insurance reliefs for pension contributions, would save billions of pounds a year, but would up-end pension administration systems and add new costs to employers who would have to change all their systems. “It is unlikely this could be introduced quickly – and could take years to be introduced,” Altmann said.

11. Abolish higher rate tax relief

Higher earners receive much more generous reliefs than basic rate taxpayers. With basic rate tax of 20%, the tax relief is equivalent to a 25% bonus added to your pension. For every £4 you put into your pension, the government adds another £1. But for a 40% taxpayer, the bonus is 66% – for every £3 you put into your pension, the Exchequer adds another £2. The deal is even better for 45% taxpayers, but the very highest earners do face the reduced annual allowances as described above.

“There have been many studies pointing out that an incentive system based on a flat-rate top up to pension contributions, rather than using tax relief, would be much fairer and would ensure the incentives are less inequitable,” Altman said.

A 25% bonus would mean everyone receives the equivalent of basic rate tax relief, so all higher or upper rate taxpayers would lose out. A 30% bonus would redistribute the £70 billion of tax and National Insurance reliefs that HMRC spends each year, so that lower and middle earners receive more help to build their pension than now, while higher earners receive less.

Altmann said: “This sounds attractive in theory, but would also be fiendishly complicated to introduce. It would probably take several years. Depending on how the new incentive ‘bonus’ would work, there could be significant long-term cost savings for the Treasury though, while enhancing its efforts to redistribute income from higher to the middle and lower earners.”

12. Turn pensions into ISAs

This option was seriously considered in 2016, Altmann pointed out, as “it would save huge amounts of money to the Treasury in the near term, because suddenly the government would not be spending any money on tax reliefs for new pension contributions”.

ISA contributions are made out of taxed income, and then there is no more tax to pay on the investment returns or on withdrawals. An ISA-Pension could operate on similar principles.

The Lifetime ISA (LISA) was an attempt to try out the concept of an ISA-Pension – where the government adds 25% to your own payments into the LISA account – but it has not proved popular.

“This radical option would, in my view, undermine pension saving,” said Altmann. “Allowing tax-free withdrawals at, say, age 60 would most likely see people cashing in their pension as soon as they can, just in case a future government changes the rules and imposes new taxes.”

The countdown to the Autumn Budget is on, with chancellor Rachel Reeves set to deliver her statement on 26 November. Weak growth, high borrowing costs, and failed spending cuts will make it a tough task, with tax hikes widely anticipated.

Given that Reeves has ruled out increases to income tax, employee National Insurance (NI), and VAT – the three main sources of revenue – pensions could be a tempting area to consider.

Pension tax relief is a frequent area of speculation given it costs the government around £50 billion per year. However, former pensions minister Steve Webb warned that cutting this tax incentive could prove complex and politically dangerous.

“Raiding pension tax relief may look superficially attractive for a cash-strapped chancellor. But lying beneath the surface are multiple traps for the unwary, meaning that reforms might raise far less than expected, break manifesto promises to workers, or put additional burdens on employers who are already under pressure,” Webb said.

“The political backlash against such reforms could easily echo previous ‘Omnishambles’ Budgets where a U-turn was made within a matter of weeks,” he added.

Webb also highlights pension tax-free cash and salary sacrifice as two other tempting but politically-dangerous areas. It is worth noting that the Treasury has not confirmed anything and does not comment on Budget rumours, however both areas have garnered attention from industry experts.

We take a closer look at the possible measures and the dangers of each.

Cutting the higher rate of pension tax relief

To encourage people to save for retirement, HMRC gives tax relief on pension contributions up to an annual limit of £60,000. This is applied at your marginal rate – 20%, 40% or 45%. It means a £100 pension contribution only costs a basic-rate taxpayer £80 of post-tax income, £60 for a higher-rate taxpayer, and £55 for an additional-rate taxpayer.

While it is a valuable incentive, pension and NI tax relief cost the government £52.5 billion in 2023/24, according to HMRC figures published in July.

Some also argue high earners shouldn’t be entitled to full tax relief. Alternative proposals include getting rid of the higher rates of tax relief (i.e. entitling all taxpayers to just 20%), or introducing a flat rate for everyone (for example, 30%).

LCP warns against cutting pension tax relief, arguing that it would constitute a major structural change to the pension system, requiring complex updates to administrative and payroll systems. This could make it difficult to raise any revenue from the policy during this Parliament.

When the idea was rumoured in the lead-up to last year’s Autumn Budget, one expert told MoneyWeek the only way to claw the money back from some pension schemes would be to impose a separate tax charge. This is because ‘net pay’ schemes take your pension contribution from your pre-tax pay. This is different to ‘relief at source’ schemes, where the tax is claimed back at a later stage.

Commenting at the time, Tom Selby, director of public policy at AJ Bell, told MoneyWeek: “If, for example, the government decided to set flat-rate pension tax relief at 30%, anyone [in a net pay scheme] earning more than £50,270 (the higher-rate income tax threshold) would be hit with a tax charge to reduce their automatic tax relief from 40% to 30%.”

“If a higher-rate taxpayer had paid a £10,000 contribution to a net pay scheme in the tax year, they would presumably need to pay a £1,000 tax charge to reduce their tax relief to the required 30%,” he added.

The changes could also prove unpopular with public sector workers. “Although public sector workers make up a minority of the workforce, the generosity of their pension arrangements and the high level of pension membership in the public sector mean we expect they would be disproportionately affected by such changes,” LCP said.

Trimming pension tax-free cash

When you turn 55, you are entitled to take 25% of your pension pot as tax-free cash, up to a maximum of £268,275 – known as the lump sum allowance. It is a popular benefit and widely understood.

The Telegraph recently said Reeves was considering cutting the allowance in this year’s Budget as part of an extensive list of money-raising proposals. However, its report also cited a Whitehall official who called reforms “unlikely”, suggesting speculation should be taken with a pinch of salt.

Similar rumours last year prompted savers to rush into taking their tax-free cash, with withdrawals surging 61%. Taking it without a plan can have negative consequences, including missed opportunities for further investment growth.

Capping tax-free cash this time around would not be a straightforward policy, as those approaching retirement would almost certainly see it as moving the goalposts. “In our view extensive transitional protections would be needed, and these would mean that extra revenue from this measure could be negligible in this Parliament,” LCP said.

Scaling back tax relief on salary sacrifice

Under current rules, employees can give up a slice of their pay in exchange for a benefit, such as a pension contribution. It is a tax-efficient arrangement, because it means you pay less income tax, and both you and your employer pay less National Insurance.

In May, a HMRC report was published looking into the possible outcome of changing the rules. The report was commissioned by the previous government in 2023, but it has raised fears that existing tax reliefs could be scaled back.

LCP argues that such a change could undermine pension saving and confidence in the system.

While cutting the higher rates of pension tax relief and trimming the lump sum allowance would largely impact wealthier pension savers, salary sacrifice is something that is accessible to those with less wealth too, provided they are willing and able to divert a portion of their current pay.

“Millions of people on modest incomes benefit from various features of the tax relief system, including the ability to sacrifice salary and benefit from a reduced National Insurance bill,” said Tim Camfield, principal at LCP.

“If this measure was scrapped, employees paying basic-rate tax and trying to do the right thing by saving for their retirement could well be losers, as well as the employers who try to provide good pensions.”

More than 420,000 more retirees will have to pay income tax this financial year amid the ongoing freeze to tax allowances.

The number of pensioners who are being taxed is rapidly increasing, with the total number of taxpayers over the state pension age expected to rise to 8.7 million – a two million increase since income tax bands were frozen in 2021.

Why are more pensioners paying tax?

Hundreds of thousands more pensioners are being pushed into paying tax because their taxable income, such as from a pension, will exceed the tax-free personal allowance – which has been frozen at £12,570 until 2028.

The Conservative government froze tax bands in 2021, as a tax-raising measure known as fiscal drag.

The frozen tax bands do not keep up with inflation, meaning more is spent on tax as incomes rise.

Fiscal drag will hit more retirees as the state pension continues to rise each year.

In April 2025, the full new state pension increased by 4.1% to £11,973, meaning even retirees who have no other income apart from the state pension are teetering on the edge of being liable to pay income tax.

The full new state pension is expected to bust the personal allowance as soon as 2027 due to the ‘triple lock’ mechanism – where the payment rises in line with the highest out of inflation (CPI), average earnings growth, or a flat 2.5%.

David Brooks, head of policy at pensions consultancy Broadstone, said a rise in pensioners facing income tax liabilities is expected given the UK’s “demographic changes due to our ageing population”, but fiscal drag was the main driver.

“While perhaps personally frustrating for many pensioners, it reflects the nature of inflation linked occupational pensions and a triple-locked State Pension that continue to rise,” he added.

“The government will be called on again to protect pensioners from this impact but with seemingly few ways to control the rise in pensioner incomes, taxation is the only tool left.”

How does tax on your pension work?

The state pension and most pensions are taxable. This means that you are liable to pay tax on part of your pension, if your annual income exceeds the tax-free personal allowance of £12,570.

In the current tax year, you will not need to pay income tax if you only receive the state pension, with absolutely no other forms of income.

However, the vast majority of pensioners have something else that boosts their income such as a private or workplace pension, earnings from employment or self-employment, investment income, rental income, or savings.

Pensioners getting the full new state pension will only be able to get £597 in other income tax-free before being tipped into the 20% basic rate tax band.

How do you pay tax on your pension?

For most people, the majority of their taxable income on top of the state pension comes from a private pension.

In this case, paying income tax is relatively simple because your pension provider typically does it for you by taking off any tax you owe before they pay you.

If you are working at the same time as getting your pension, your employer will usually take any tax you owe off your earnings under the pay as you earn (PAYE) system.

However, if you are self-employed, you must fill in a self assessment tax return at the end of the tax year. On the tax return, you must declare your overall income, including the state pension and money from private pensions.

If you are earning extra income on top of your state pension in any other ways, such as rental yields, you will also have to report it in a self assessment tax return.

If you owe any tax on investment income, HMRC will send you a calculation telling you how much you owe and how to pay it.

Unspent pension savings will be brought inside the inheritance tax net from April 2027 after changes announced in the 2024 Autumn Budget. This could see some families paying an effective tax rate of 67%.

Double taxation is to blame. On top of any inheritance tax liability, beneficiaries will have to pay income tax on pension withdrawals that exceed the personal allowance, unless the original pension holder died before age 75.

Due to the way the tax is deducted, this will create an effective tax rate of 52% for basic-rate taxpayers, 64% for higher-rate taxpayers, and 67% for additional-rate taxpayers.

How does pension double taxation work?

Imagine you inherited a pension worth £100,000 from someone who died after age 75 and who had already used up their tax-free allowances (known as the nil-rate bands) on other assets. First of all, you would have to pay a 40% inheritance tax bill, taking the value of the pot to £60,000.

Any withdrawals from the remaining £60,000 would be taxed at your marginal rate – 20% for basic-rate taxpayers, 40% for higher-rate taxpayers and 45% for additional-rate taxpayers.

• Basic-rate taxpayers: Twenty percent of £60,000 is £12,000, so you would be left with £48,000 after tax. In other words, the taxman takes 52p in every pound.
• Higher-rate taxpayers: Forty percent of £60,000 is £24,000, so you would be left with £36,000 after tax. The taxman takes 64p in every pound.
• Additional-rate taxpayers: Forty-five percent of £60,000 is £27,000, so you would be left with £33,000 after tax. The taxman takes 67p in every pound.

As the above figures show, the IHT changes have significant implications for your estate planning. Pensions have gone from being one of the most tax-efficient vehicles for IHT planning to potentially one of the least tax-efficient.

Those whose estate is close to £2 million in value should be particularly careful, as you start to lose a valuable tax-free allowance (the residential nil-rate band) at this point. This is worth £175,000, and can be used alongside your regular £325,000 nil-rate band if you are leaving the family home to a direct descendant.

If you are close to the £2 million threshold, your pension assets could push you over the line once the new rules kick in from April 2027.

Against this backdrop, more retirees are withdrawing bigger sums from their pensions to avoid losing their savings to the taxman.

Surge in pensioners taking more from their pensions

Financial advisers are reporting a surge in clients taking more from their pensions ahead of the retirement funds becoming subject to inheritance tax, according to new research from advice firm Wesleyan.

The vast majority (90%) of advisers polled said they had seen an increase in clients speeding up their pension drawdown in anticipation of the reform, in a survey of 300 UK-based financial advisers conducted between 24th March and 30th April 2026.

Three quarters (74%) said clients are typically increasing their annual pension withdrawals by between 5% and 15% due to IHT concerns. Nearly a fifth (18%) said retirees are upping withdrawals by more than 16%.

Advisers have flagged the long-term impact of higher amounts of pension drawdown on retirees ’ finances: 90% of advisers said they were concerned about the volatility drag (90%) – where market fluctuations erode returns over time – and sequencing risk (88%) – the danger of poor investment returns early in retirement reducing the sustainability of withdrawals.

Karen Blatchford, managing director of distribution at Wesleyan said: “While it’s understandable clients are looking to act ahead of inheritance tax changes, advisers know that increasing withdrawal levels can have significant consequences, especially in the uncertain and volatile market conditions we’re experiencing today.

“That makes it vital that any changes to withdrawal strategies are supported by robust planning and advice to help clients maintain long-term financial resilience.”

Retirees are also weighing up which assets to draw down first, and which tax wrappers to contribute to in the first place. Drawing on ISA wealth before your pension used to be the obvious route, as pensions were exempt from inheritance tax while ISAs were not. The upcoming changes have complicated the picture.

Should you change your retirement plans to reduce your IHT bill?

Pensions are still the best way for most people to save for retirement thanks to the tax relief and employer contributions you get if you’re employed. It is usually a bad idea to stop or reduce your contributions, as you still need to build retirement income.

If you’re retired and are comfortable that you will have excess savings left over after you die, consider upping your pension spending. This could allow you to leave other assets like ISAs untouched, which could then be given to your loved ones instead of your pension after you die.

Like pensions, ISAs are still subject to IHT but your beneficiaries won’t have to pay income tax when they withdraw money from an inherited ISA. This could be particularly beneficial if they are an additional-rate taxpayer, likely to fall victim to the 67% tax trap. Just remember that ISAs are not as tax-efficient as pensions on the way in, as you do not benefit from tax relief on contributions.

Also be mindful of your own tax considerations, as upping your pension withdrawals could mean you end up paying more income tax yourself.

“We would always advise clients to consider the income tax they will pay when planning pension withdrawals, but this question is becoming more important now that more savers are looking to take greater amounts out,” said Gary Smith, financial planning partner at Evelyn Partners.

“Those now looking to spend or gift more of their pension funds need to keep an eye on the tax they will pay as they withdraw funds, because that is a definite liability they will have to pay, whereas in some instances the IHT might only be a notional future problem,” he added.

“If possible, keeping one’s taxable income on the right side of the next tax band can make sense, so for many people this might mean measuring their pension withdrawals so they do not push total annual income above £50,270 into higher-rate tax at 40%.”

Gifting to reduce your inheritance tax bill

You could also consider giving some of your pension wealth away in your lifetime to reduce your IHT bill. There are strict rules around gift-giving, but everyone has an annual gifting allowance of £3,000. Anything more than this, and you will usually need to outlive the gift by seven years to avoid IHT, known as the seven year rule.

There is also an exemption for regular gifts made out of “surplus income”, so you could consider something like setting up a direct debit into a grandchild’s Junior ISA. Don’t overdo it though; nobody knows how long they will live and it is important to consider future expenses like the cost of care.

Chancellor Rachel Reeves will deliver her Spring Statement on 26 March and there are plenty of rumours about what could be announced.

These include reducing the cash ISA allowance, cutting government spending and increasing taxes. However, it is now understood there won’t be any change to the cash ISA limit next week, although a shake-up to the ISA rules could still be announced at a later date.

The Spring Statement will follow a Spring Forecast from the Office for Budget Responsibility (OBR), the UK’s fiscal watchdog.

While the government says it is “committed to one major fiscal event a year” – presumably the Autumn Budget rather than the Spring Statement – speculation is mounting that we could still see some tax and spending changes in next week’s statement.

“Is it a Spring Forecast? A Spring Statement? Dare we even say it – a mini-Budget?” comments Tom Selby, director of public policy at AJ Bell.

“Whatever label the chancellor puts on her set piece announcement on 26 March, the economic picture the OBR paints is expected to be grim, with fears of stagnation looming and the spectre of rising defence costs as Donald Trump’s US government retreats from Europe further threatening to strain the public purse.”

He adds: “Against such a challenging backdrop, there is a growing expectation that tough fiscal measures are in the offing, despite the chancellor’s insistence there would be no return to austerity.”

If Reeves is wondering how to balance the books, it’s possible we could see some changes to pensions. The government has already targeted pensioners and pension savers since getting into power last year, such as by means-testing the Winter Fuel Payment, and hitting pension pots with inheritance tax.

We look at potential pension announcements in the upcoming Spring Statement.

State pension

We already know the state pension will rise by 4.1% next month. But, the huge bill of paying the state pension, along with the commitment to the triple lock, could be a target for a government keen to slash costs.

Steven Cameron, pensions director at Aegon, warns: “If the OBR’s report and other budgetary pressures are worse than anticipated, we can’t rule out a ‘rabbit in the hat’ review of the state pension. There’s already an ongoing review of the state pension age and government finances may mean it needs to increase further or faster.”

He adds that the state pension triple lock could also come under scrutiny, as it’s proven costly and unpredictable in recent years. “While the government has currently committed to keeping it, the formula might be adapted. Instead of annual increases being the highest of earnings growth, inflation, or 2.5%, a smoothing mechanism could be introduced.”

According to Cameron, pensioners might receive an inflation increase as a minimum, and if, over the previous three years, wage growth has on average been higher than inflation, they could receive an additional uplift. “This would protect pensioner purchasing power and make future costs less unpredictable,” he adds.

Pensions and inheritance tax

Reeves announced in last year’s Autumn Budget that pension pots would become subject to inheritance tax (IHT) from April 2027.

This was something of a surprise, and many pension experts responded by saying the policy would penalise prudent savers and their loved ones, while adding complexity.

A government consultation into how the rule change would work has now ended, and it’s possible Reeves might use the Spring Statement to give an update.

Steve Webb, partner at pension consultants LCP, and a former pensions minister, tells MoneyWeek: “At a stretch, we might get an update on plans to apply IHT to pensions, perhaps saying that HMRC are going to do a further consultation because although the policy hasn’t changed they want to make it less onerous on individuals (and pension schemes).”

Selby adds: “Given there were reportedly hundreds of responses to the consultation, the Spring Statement may come too soon for the chancellor to give detailed feedback. She could, however, use the opportunity to give an indication of whether she is willing to consider doing things differently, or if the Treasury is committed to its IHT plans.”

Tax allowances

There is speculation that Reeves might extend the Tories' freeze on tax thresholds beyond 2028. This would drag more people into paying tax, and higher rates of tax.

“The freeze on allowances is due to end in 2028 but in light of the fiscal straitjacket Reeves finds herself in, extending this to 2030 could raise some much-needed cash for the Exchequer,” comments Selby.

Frozen tax allowances mean that as people’s wages rise, they are dragged into higher tax brackets. The combination of a static tax-free personal allowance and rising state pension thanks to the triple lock also means that many pensioners will soon have to start paying tax on their state pension.

Selby notes: “The Treasury may be comfortable giving with one hand through state pension increases while taking with the other via income tax, but it also leaves the door open for the Conservatives to accuse the government of hitting pensioners with a ‘retirement tax’.”

Workplace pensions

According to Webb, it’s possible there could be an update on government plans to create defined contribution pension “mega funds”, as trailed in the Autumn 2024 Mansion House speech, by forcing consolidation of smaller schemes.

We may also hear about reforms aimed at encouraging pension schemes to invest more in the UK economy.

Selby comments: “The second stage of the Pensions Review, focused on adequacy, has yet to materialise and Reeves could provide an update on the government’s thinking in the Spring Statement.

“There are significant challenges to overcome here, principally how and when to scale up minimum automatic enrolment contributions from 8% of ‘qualifying earnings’. Having already significantly hiked costs on employers in her October Budget and with the government focused on delivering improved economic growth numbers, there is every chance this particular reform will find its way into the political long grass.”

Pensions tax relief

With an uncertain economic backdrop, and a government that likes to surprise us (see: IHT on pensions; Winter Fuel Allowance; refusing to pay Waspi compensation, to name just three), could the Spring Statement spring a pension shock on all of us?

Tomm Adams, partner at tax firm Blick Rothenberg, tells MoneyWeek: “We’ve already had one nasty pensions surprise in the first year of the Labour government, with the announcement that pensions will be brought into the scope of inheritance tax. Very few predicted this; instead, we were all speculating over some kind of cuts to income tax relief either on pension contributions or on benefits taken in retirement. For example, reducing the tax-free lump sum from 25% of the pot to say 20% or even 5%.”

He adds: “I don’t imagine the chancellor will backtrack on this inheritance tax raid in her Spring Statement, but could she cut income tax relief after all? To do so would be disastrous for millions of ordinary people looking to do the right thing by saving long term. Short-term Treasury gains would come at the cost of a serious, long-lasting impact on savers’ confidence in the UK pensions system and a real impact on the lives of future pensioners.”

Retirees may have to pay tax on their state pension as early as next year, according to new forecasts.

The full state pension could soar by 5.5% to reach £12,631 a year in April 2026, due to the triple lock.

If this happens, it would breach the £12,570 tax-free personal allowance, and the excess would be taxed at the pensioner’s highest income tax rate.

The triple lock dictates that the payment is increased each year by annual earnings, inflation or 2.5%, whichever is higher. The full new state pension is currently worth £11,502 a year, and will rise by 4.1% to £11,973 this April.

It was previously thought that the state pension wouldn’t be subject to tax until April 2027, according to Office for Budget Responsibility (OBR) forecasts released alongside the Autumn Budget.

But, analysis by Deutsche Bank suggests that strong wage growth will push the state pension up faster than expected.

Figures released this week revealed that wage growth in the UK hit 5.9% in the three months to December 2024. However, the state pension triple lock uses annual earnings in the three months to July, and it’s this figure that Deutsche Bank predicts could come in at 5.5%.

Sanjay Raja, Deutsche Bank’s chief UK economist, comments: “As of right now, our projection for average weekly earnings total pay in the three months to July sits at 5.5% year-on-year. Our September 2025 CPI inflation projection sits just around 4.25%.

“Therefore, based on our current projections we see state pensions rising by 5.5% in April 2026.”

Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, the online investment platform, tells MoneyWeek: “Paying tax on state pension income will feel very unfair, particularly for those who solely rely on the benefit to make ends meet. Making tax demands on retirees with no other sources of income will be extremely worrying for pensioners who are already struggling with higher living costs.”

She adds: “Meanwhile, those receiving a private pension income will simply see even more of that money swallowed up by tax as a result of frozen income tax thresholds.”

Ros Altmann, a former pensions minister, warns that making the state pension liable for tax could be an “administrative nightmare”.

She comments: “Many pensioners have never paid tax in their life. Those with private pensions or the younger ones who receive the new state pension and are not on the old [state pension] system may get a simple assessment form to help them know what tax and how to pay it.

“But the older ones would have to fill in a tax return. Can you imagine 90-year-olds being told they owe a few pounds in tax and must fill in a tax return, or face fines and penalties?”

Why will retirees have to pay tax on their state pension?

Millions of retirees already pay income tax because they receive extra money on top of their state pension, such as from a buy-to-let, part-time work or a personal or workplace pension.

But those receiving the full state pension and no other income in retirement – who would be regarded as some of the poorest pensioners – will also be dragged into the tax net if the payout rises above the personal allowance.

The £12,570 personal allowance is frozen at its current level until 2028, meaning each annual uprating to the state pension could increase the tax liability.

If the full state pension rose to £12,631 a year next April, as predicted by Deutsche Bank, the £61 above the personal allowance would be taxed. For a basic-rate taxpayer, this would create a £12 tax bill. For a higher-rate taxpayer, the bill would be £24.

The OBR previously forecast a 2.6% rise in the state pension for next April. It then said the state pension would increase to £13,230 a year by 2029.

If the freeze on the personal allowance was extended beyond 2028, and the 2029 OBR prediction was correct, it would mean the state payout would be £660 above the allowance in four years’ time. This would trigger a £132 tax bill for basic-rate taxpayers, while higher-rate taxpayers would need to pay £264.

Is the retirement tax unfair?

Former prime minister Rishi Sunak coined the term “retirement tax” on the election campaign trail last year after he claimed that a Labour government would subject the state pension to a "retirement tax”.

Sunak froze income tax thresholds until 2026 in the 2021 Spring Budget when he was chancellor. The freeze was later extended to 2028 by former chancellor Jeremy Hunt.

The Conservatives said it would introduce “triple lock plus” to avoid the state pension being liable for income tax. This was to be a new personal allowance for retirees, which would rise in line with the triple lock – therefore keeping pace with the state pension and reducing the risk of them being taxed.

However, Labour did not commit to such a policy, and now in government, it has not unveiled any measures to protect pensioners from tax as the state pension rises.

Clare Moffat, pensions and tax expert at Royal London, notes: “The previous government had set out proposals to avoid any income tax being paid on the state pension, but it is unclear whether those will be revisited. It would make little sense to have a situation where the state is paying you an increased pension on one hand but taking some of it back in tax on the other.”

According to Royal London, the most recent data from HMRC shows there’s been an increase of two million over-65s paying tax since 2020/21, and “that would rise substantially if the state pension increased to over £12,570”.

Haine says if the state pension rose above the personal allowance it “could put pressure on the government to unfreeze the personal allowance to prevent retirees being taxed on this vital benefit or reconsider whether more radical action is needed”.

A Treasury spokesperson said: “The state pension is the foundation for ensuring pensioners are able to live with the dignity and respect they deserve.

“We are committed to the triple lock, and pensioners whose sole income is the new state pension and who have not deferred or receive protected payments do not pay any income tax.”

The misery of applying for pension tax refunds has been dragging on for a decade - but the end may be in sight after HMRC announced it will reform the system from April.

Thousands of retirees are overtaxed on their pension withdrawals every year, and must try to get a refund from HMRC.

A massive £1.37 billion has been reclaimed by people overtaxed on pension withdrawals since 2015.

In the last three months of 2024, more than 14,600 repayment claims were processed, amounting to almost £50 million.

Critics have long called the situation a “tax nightmare” and a “scandal” while pointing out that a shock tax bill is not a nice way to start retirement.

But now HMRC says it wants to improve the system by quickly taking retirees off emergency tax codes and making sure they aren’t overtaxed.

Sir Steve Webb, partner at pension consultants LCP and a former pensions minister, said reforming the “scandalous system” feels like a big breakthrough after complaining about it for years.

“For too long, hundreds of thousands of people have been overtaxed and had to jump through hoops to claim back their own money. This new system should mean that far more people are quickly moved on to the correct tax code and no longer end up with an overpayment of tax,” he commented.

Why do pension withdrawals get overtaxed?

The overtaxation typically happens when a retiree accesses their pension for the first time and pays an emergency rate of tax.

Pension savers are allowed to take money out of their self-invested personal pensions (Sipps) and workplace schemes as they wish from age 55 (rising to 57 in 2028). So, for example, they could withdraw £500 one month, £2,000 the next month, and nothing for the rest of the year.

Pension withdrawals are subject to income tax, bar the 25% tax-free cash. HMRC taxes the first flexible withdrawal someone makes in a tax year on a “Month 1” basis. This means the withdrawal is taxed as if that will be the retiree’s income every month for the rest of the tax year.

That can lead to far too much tax being taken off the pension payments.

The latest HMRC figures reveal that people are claiming back an average tax refund of £3,390.

Tom Selby, director of public policy at AJ Bell, notes: “This is likely only the tip of the iceberg, however, as it only captures those who fill in the relevant HMRC reclaim form. In reality lots of people, such as those on lower incomes who are less familiar with the self-assessment system, will not go through the official process of reclaiming the money they are owed.”

What has HMRC announced?

Tucked away in a routine newsletter to pension schemes, HMRC said that from April 2025, it will improve “how tax code information is used for those people who are new to receiving a private pension, so they pay the right amount of tax from the outset”.

It goes on: “We will automatically update the tax code for customers who are on a temporary tax code and would benefit from being on a cumulative code - this means they’ll avoid an overpayment or underpayment at the end of the year. There is no need to contact HMRC and once a tax code has been changed we’ll inform customers by letter or digitally if they’ve signed up for paperless in the HMRC app or online."

Webb says the change “should hopefully reduce the complications which pension savers face when they try to access their hard-earned cash”.

He adds that the reform will “drastically reduce the need either for end-year reconciliations or form-filling to claim back over-paid tax, particularly where people make multiple withdrawals in a single year”.

However, Selby warns that the reforms don’t go far enough, as they won’t help “those people taking ad-hoc lump sums from their drawdown pot and still means the first payment for all will be overtaxed”.

Jon Greer, head of retirement policy at the wealth manager Quilter, calls the planned reforms “promising”, but adds that “it remains to be seen whether they will fully address the complexities and inefficiencies of the current system”.

How can pensioners claim a tax refund?

If you are taking a steady stream of income via drawdown then you shouldn’t need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year you are taxed the correct amount.

However, if you are hit with emergency tax due to a single withdrawal or ad-hoc withdrawals, you can either complete a form and apply for a refund, or wait for HMRC to put you in the correct position at the end of the tax year.

Which form you need to fill out will depend on how you have accessed your retirement pot:

• If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z
• If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z
• If you’ve only flexibly accessed part of your pension pot then use form P55

Refunds are usually paid within 30 days and are sent directly to your bank account.

Rachel Reeves’s announcement on Budget Day that pensions would fall into the scope of inheritance tax was not entirely surprising.

There had been speculation this could happen, and it was perhaps a better outcome than some of the other pension shock rumours. These included slashing the amount of tax-free cash a retiree could take, or cutting pension tax relief.

However, now the dust is starting to settle on last week’s Budget, it’s becoming clear how making pension pots liable for inheritance tax could have huge implications for people’s retirement plans - and one that could see bereaved families paying a double tax of up to 67%, or in some cases, as much as 90%.

“Bringing pensions into the inheritance tax regime will have a big bearing on how people approach passing on wealth to their loved ones,” comments Julie Hammerton, managing partner at Hymans Robertson Personal Wealth.

“The order in which people access their long-term savings will likely change. This sequencing is something that those in the fortunate position to have savings will need to get their heads around.”

From a financial planning perspective, the general rule on drawing on your ISAs first in retirement, before pensions, could be turned on its head. Downsizing could become more attractive, and so could annuities.

Ed Monk, associate director at Fidelity International, adds that pension savers “may find they need to reorganise their savings and alter their planned sources of retirement income in order to remain tax-efficient”.

We look at how the chancellor’s inheritance tax (IHT) plans will work in practice. If you’ve built up a large pension pot to pass onto loved ones, should you rethink your retirement strategy, and what are your options to prevent a double death tax whammy?

Pension tax: what was announced in the Budget?

Reeves announced in the Autumn Budget that pension pots would form part of the estate for IHT purposes, meaning bereaved families face paying up to 40% on inherited retirement savings.

The government will bring unused pension funds and death benefits payable from a pension into a person’s estate from 6 April 2027.

According to the Treasury, “bringing unspent pots into the scope of inheritance tax will affect around 8% of estates each year".

This figure may not seem that high, but experts are urging pension savers to check, and potentially change, their retirement strategies to avoid a big tax bill - especially given that slapping IHT on pensions is expected to cost people an incredible £1.46 billion in 2029/30.

How will IHT work on pensions?

IHT only begins to apply when an estate - which includes property, investments, cash and other possessions - reaches £325,000.

This is known as the nil-rate band. Anything over this threshold faces 40% tax, but there are several exemptions that can give you more headroom.

First, money passed to a spouse or civil partner attracts no IHT at all. So, if you leave your pension to a husband, wife or civil partner there will be no inheritance tax to pay - and this will continue to be the case when the new rules come in.

It is possible for families to pass on as much as £1 million with no IHT to pay - this involves passing your nil-rate band to your spouse or civil partner when you die, and then leaving a primary residence (in other words, your home) to direct descendants.

However, if you are not married or in a civil partnership, and do not leave your home to a direct descendent (which includes children, grandchildren, step-children and adopted children), your nil-rate band remains at £325,000.

Currently, pensions do not form part of the saver’s estate for inheritance tax purposes. From April 2027, if your estate breaches your nil-rate band, the surplus is taxed at up to 40% (you get a reduced rate of 36% if you leave at least 10% of your net estate to charity).

So, where 40% inheritance tax is due, £1,000 of pension money would have £400 removed in tax, leaving the beneficiary £600.

Why will we see a “double tax” on pensions?

Beneficiaries also have to pay income tax on inherited pensions, depending on when the pension holder dies.

If death occurs at or after age 75, the pension money is subject to the beneficiary’s rate of income tax.

Monk explains the double tax that will kick in from April 2027: “For example, where IHT is due, £100 of pension money would be subject to 40% IHT, leaving £60. If death occurs after age 75, this money would then be subject to the beneficiary’s rate of income tax. In the worst case this would be 45%, resulting in just £33 being received by the beneficiary - an effective tax rate of 67%.”

The government is consulting on the exact details of how inheritance tax should be paid on pensions; further details are expected next year.

Hammerton adds that the “changes won’t come into effect until close to the end of the current government’s term in office”, meaning there is “a risk these policies could be reversed if a new administration came into power.”

However, experts agree that anyone who thinks their assets may be liable for IHT, or has a large pension pot that they’re not touching because they want to pass it onto a loved one, should start taking action now.

Could a beneficiary really be hit with a 90% tax rate?

There are some families who may find the additional tax burden weighs more heavily on them than others.

In some instances, the addition of a pension fund to someone’s IHT estate will result in them losing the residence nil-rate band (RNRB). This is the tax-free amount of up to £175,000 that can help reduce someone’s IHT liability in respect of residential property they pass on.

"If someone’s estate for IHT purposes exceeds £2 million, the RNRB starts to be reduced. It is reduced by £1 for every £2 over £2 million, meaning someone with an estate of £2.35 million will have no RNRB available to them," comments Chris Etherington, partner at tax firm RSM.

He adds that based on the expected operation of the new pension rules, it is possible that someone with other assets of £2 million and a pension pot of £350,000 could find a high effective IHT rate applies to the pension and overall estate due to the loss of the RNRB of up to 60%.

"If the pension is then withdrawn as income, there could be a further layer of tax applied to the pension funds. An additional-rate taxpayer resident in England, Wales or Northern Ireland would incur tax at a rate of 45% on such funds, whilst a Scottish resident would incur a rate of up to 48%."

According to Etherington, the net result is that a Scottish beneficiary of the estate in these circumstances may only receive as little as £29,906 cash from the £350,000 pension pot. That works out as an effective overall tax rate on the pension pot of 91.46%. An English, Welsh or Northern Irish beneficiary of the same pot could have a net receipt as low as £36,787, representing an 89.49% overall tax rate.

He adds: "The new pension IHT rules are undoubtedly going to make matters more complicated from an administrative perspective and the calculation of IHT liabilities is set to become more complex."

Steps to take to avoid a big tax bill

To avoid leaving your family with a tax liability, the simplest thing to do is to reduce the value of your estate to below your nil-rate band.

You can give away up to £3,000 each year, which will fall within your annual gift allowance. There are additional allowances for gifts made for specific purposes. You can give £1,000 to anyone you like to help pay for their wedding, and this rises to £2,500 for a grandchild and £5,000 for a child. The gift has to happen before the big day, not after.

There’s a separate rule that means you can give away surplus income inheritance-tax free too. You need to pay it from your regular monthly income and have to be able to afford the payments after meeting your usual living costs.

You are also allowed to give money to pay for the living costs of a child under age 18, or in full-time education, such as at university. This money should not be excessive, and only enough to cover living costs and tuition fees.

If you gift money beyond these rules, it becomes what’s known as a “potentially exempt transfer”, which falls out of your estate after seven years have passed.

As well as cash gifts, you could consider contributing to a loved one’s pension, such as your partner or a child, or paying into a grandchild’s junior ISA.

Downsizing can also lower the value of an estate, and this could be particularly useful if you don’t have direct descendents to leave your home to, and therefore don’t benefit from the increased nil-rate band.

Of course, this is a big decision and needs to be weighed up in terms of emotional and lifestyle factors as well as incurring other costs like stamp duty.

Buying an annuity could also help, as you’re getting rid of your pension pot and receiving a guaranteed income stream instead. If you want to leave a retirement income to your spouse or civil partner, you can buy a joint annuity. This can be inherited tax-free.

Meanwhile, the conventional wisdom to spend ISAs before pensions will become redundant, as both will be treated the same for IHT purposes.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, comments: “The likelihood is we will see people looking to spend down their pensions as retirement income rather than leave them untouched, a move which could keep the rest of someone’s estate below the IHT threshold.

“We may also see an increased interest in annuities as people look to secure a guaranteed income while also keeping their estate below the inheritance tax threshold.”

Something else to consider is a life insurance policy in trust. “If you are concerned about how your family will pay any inheritance tax bill, then you can take out a life insurance policy placed in trust to cover the amount. You will need to pay a monthly premium which depends on how old you are when you took out the policy and your health, but it could be a great way to give you and your family peace of mind,” notes Morrissey.

The chancellor has announced an inheritance tax crackdown that will see pension pots and Aim shares subject to the tax.

Rachel Reeves said in her Budget speech that only 6% of estates will pay inheritance tax (IHT) this year, and that she wanted to take a “balanced approach” to changing the tax in a bid to raise revenue.

Experts had been worried that the nil-rate band (the tax-free allowance for inheritance tax) could be cut, or the 40% rate increased.

The chancellor decided against this, instead extending the freeze on the £325,000 nil-rate band to 2030.

She also announced reforms to business and agricultural property relief - affecting Aim shares - and said pension pots would form part of the estate for IHT purposes, meaning bereaved families face paying up to 40% on inherited retirement savings.

Craig Rickman, personal finance and pensions expert at Interactive Investor, comments: “Reeves’ move to scrap the IHT exemption on unspent pension savings is bold, and will be a blow to savers who have beefed up their retirement pots to harness the estate-planning perks.

“Presumably this means that your pension pot will form part of your estate on death and unless your heir is a spouse or civil partner, they will pay 40% tax on anything that exceeds your tax-free allowances. This will reduce the allure of cascading pension pots down generations."

Inheritance tax on pensions

The government will bring unused pension funds and death benefits payable from a pension into a person’s estate for inheritance tax purposes from 6 April 2027.

The Budget document said: “This will restore the principle that pensions should not be a vehicle for the accumulation of capital sums for the purposes of inheritance, as was the case prior to the 2015 pensions reforms.”

According to the Treasury, “bringing unspent pots into the scope of inheritance tax from April 2027 will affect around 8% of estates each year".

The measure is forecast to raise £640 million in 2027-28, rising to £1.3 billion in 2028-29 and £1.5 billion in 2029-30.

Tom Stevenson, investment director at Fidelity International, says the announcement was “largely expected” as the inheritance tax exemption for pension pots “is something of an anomaly”. He adds: “This will prompt some rethinking of retirees’ decumulation strategies because it is no longer quite so obvious that they should draw down their ISA savings before tapping into their pensions. It could make annuities relatively more attractive for some.”

Inheritance tax on Aim shares

Reeves also cut business property relief and agricultural property relief. From April 2026, inheritance tax will apply at a reduced rate after the first £1 million of business and agricultural assets.

This will be levied at 50%, giving an IHT rate of 20% (half of the 40% rate).

Aim shares will also no longer be exempt from IHT. The government is reducing the rate of business property relief to 50% in all circumstances for shares designated as “not listed” on the markets of a recognised stock exchange, such as Aim. This also means an IHT rate of 20%, and again, it will kick in from April 2026.

According to official forecasts, the move will affect around 0.3% of estates each year.

Stevenson comments: “The exemptions for farmland and Aim shares have been significantly reduced which is bad news for the junior market, which has already underperformed badly this year. There will be relief, however, that speculation around the rules on gift giving seem to have come to nothing.”

Richard Stone, chief executive of the Association of Investment Companies (AIC), adds: “Bringing all Aim shares and pension funds into the scope of inheritance tax will act as a disincentive to build and retain those long-term investments for the benefit of future generations.”

Extending the nil-rate band freeze

Reeves said that the £325,000 nil-rate band will remain at this level until April 2030. The residence nil-rate band of £175,000 (giving a total of £500,000 when used together) will also be frozen until this date.

While experts concur that the inheritance tax changes announced today were not as bad as feared, the effect of freezing a threshold can have far-reaching implications.

Rachael Griffin, tax and financial planning expert at Quilter, comments: "The decision to continue the freeze on the IHT nil rate band (NRB) at £325,000 will pull many more estates, which many would consider relatively modest, into the inheritance tax net.

"The NRB has been frozen since 2009 and if it had risen in line with inflation, it should now be £503,879 so freezing this until 2030 will make this threshold even more antiquated. We are already seeing record-breaking IHT receipts, and this change will compound this."

Savers are racing to top up their pensions and gain valuable tax relief, while retirees are grabbing their 25% tax-free lump sums amid fears that the chancellor could slash popular pension perks in the Autumn Budget.

The government has repeatedly warned that it will have to make “difficult decisions” in a bid to raise revenue, and that the Budget will be “painful”. Two days before the Budget - which takes place on 30 October - Keir Starmer confirmed that there would be tax rises, and said that Britain "must embrace the harsh light of fiscal reality".

Speculation has been mounting that Labour could change the rules on pension tax relief, with high earners losing out - however, chancellor Rachel Reeves is now believed to have abandoned these plans, according to media reports.

The government could also cut the 25% tax-free cash that pension savers are allowed to withdraw from age 55. Reeves is understood to be considering reducing the maximum to £100,000.

Investment platforms have told MoneyWeek that they have seen a change in customer behaviour in the run-up to Reeves’ maiden Budget on Wednesday.

Bestinvest saw a tenfold increase in self-invested personal pension (Sipp) contributions in September, compared to the same month in 2023, with payments also quadrupling compared to August this year.

Alice Haine, personal finance analyst at Bestinvest, says that while the chancellor is now rumoured to be reconsidering plans to cut pension tax relief, "a summer of speculation prompted nervous savers to funnel large sums into their Sipps to get ahead of any changes".

Hargreaves Lansdown has seen a 69% rise in the number of clients contributing the maximum amount to their pension pots between 6 April and 18 October, compared to a year earlier.

Savers can pay in up to £60,000 into a pension each tax year and gain tax relief at their highest marginal rate, thanks to the annual allowance.

Interactive Investor reports a similar picture, with the number of Sipp customers contributing the full £60,000 increasing by 64% since the start of the tax year, compared to the same period in 2023.

AJ Bell said it had also seen signs of savers boosting their contributions.

Meanwhile, Bestinvest said the number of pension withdrawal requests more than doubled in September this year compared to the same month in 2023 – a surge primarily driven by those aged 55 and over accessing their 25% tax-free lump sum as uncertainty prompted people to drastically alter their pension saving behaviour.

Interactive Investor saw a 58% uptick in the volume of cash withdrawals from Sipps that make up part or all of the 25% tax-free lump sum allowance in the first two weeks of September, compared to the same period last year.

Myron Jobson, senior personal finance analyst at Interactive Investor, comments: “With the swirling rumours of changes to the UK pension regime, it’s understandable that many might feel a bit jittery about the future of their retirement savings.”

AJ Bell also saw a rise in people taking their tax-free lump sum in recent months, which “may be due to fears about a possible Budget raid on tax-free cash”.

So, should you also take action ahead of the Budget? While no one knows for sure what the chancellor’s red box will contain, we look at whether there are moves you could make now to prepare.

Consider increasing your pension contributions…

Pensions are a popular area for governments to play with when considering how to raise funds and plug deficits.

The £60,000 annual allowance could be reduced, while Labour may choose to look at pension tax relief too. Higher and additional-rate tax relief could potentially be scrapped, with a flat rate of say 25% or 30% introduced.

However, meddling with pension tax relief would be complicated, and if the government was planning such a move it’s unlikely it would happen straight away. In addition, The Times has reported that Labour is expected to abandon its plans to change pension tax relief after senior Treasury officials told the chancellor the policy would hit public sector workers on "relatively modest incomes".

Having said that, if you have spare cash and are thinking of boosting your retirement nest egg anyway, it could make sense to pay it into a pension now before Budget day.

Hargreaves Lansdown has also seen a 19% jump in those who chose to contribute exactly £3,600 to a pension, which is the maximum that can be paid into the Sipp of a non-working spouse or child.

According to Helen Morrissey, head of retirement analysis at the investment platform, this could indicate that people are taking the opportunity to not just bolster their own pensions, but those of their loved ones too - so you may wish to consider doing this too.

…but don’t rush into taking your tax-free cash

Labour may also look at changing the 25% tax-free cash that pension savers can withdraw from age 55 (the other 75% of their pension pot is liable for income tax). Possible changes include lowering it to 20% - or even axing it altogether - and/or slashing the maximum tax-free amount (£268,275) that savers can take.

Last month, the Fabian Society, a think tank, called for the tax-free cash allowance to be cut to £100,000. And the Telegraph has reported that Reeves is considering the idea.

A poll of advice professionals conducted by abrdn reveals that cutting the pension tax-free lump sum would be the most disruptive out of any mooted Budget measures.

However, experts caution against taking your tax-free cash now simply because of Budget rumours.

Morrissey notes: “The 25% tax-free cash has been around since the late 80s and Labour said it was a 'a permanent feature of the tax system' in the election campaign.

“[However, there are] suggestions that the chancellor might look to trim back the amount of tax-free cash people can take from their pension. Ripping this out of your pension now to avoid a tax grab may seem like a good idea, but it’s something you may come to regret.”

She says savers need to have a plan for what they do with their tax-free cash. “Simply taking it and putting it in a bank account paying a low interest rate means that money misses the potential for further investment growth in the pension. Investments within a pension also grow free of tax, and unless you’re taking £20,000 or less, and putting it in an ISA, you'll lose that protection against tax,” she explains.

Morrissey adds that under current rules, money in a pension is usually free of inheritance tax – “this is not the case with money in ISAs or bank accounts so there’s also the chance that taking your tax-free cash now could land your family with a nasty tax bill in future”.

Do a “Bed and Pension” to escape a potential capital gains tax hike

Experts say it is highly likely that capital gains tax will get a mention in Reeves’s Budget. Potential changes include raising the rates (possibly in line with income tax), cutting the tax-free allowance, changing how and when CGT is levied, and removing reliefs.

Some investors and pension savers are trying to get ahead of this by doing a “Bed and ISA” or “Bed and Pension” transaction now before 30 October.

Bestinvest says Bed and ISA instructions are up by a quarter since Labour came into power in July, compared to the same period in 2023, “as investors consider the tax efficiency of their investments under the new government”. The digital wealth manager Moneyfarm has also seen “a sharp increase in clients liquidating their positions” and rebuying the investments in tax-efficient wrappers, so they can lock in gains at the current CGT rates.

The transaction allows savers to sell investments held in a taxable environment and repurchase them within an ISA or pension – a move that effectively shields those assets from a potential CGT hike provided they don’t breach their CGT exemption of £3,000. “It also serves to protect any future income or gains from tax, making a savers’ investment portfolio more tax-efficient over the short and long term,” comments Haine at Bestinvest.

If you have investments held outside an ISA or pension, it could be a good idea to act now and do a Bed and ISA or Bed and Pension.

By doing a Bed and Pension, in particular, you can take advantage of today’s CGT rates and pension tax relief and shield yourself from any Budget changes.

The misery of applying for pension tax refunds is still dragging on, with HMRC paying out £44 million in the third quarter of this year to pensioners who have been overtaxed.

More than 12,000 reclaim forms were processed by HMRC from July to September, with an average pension tax refund of £3,691.

The over-taxation occurs when too much tax is taken off withdrawals from pension pots. It typically happens when a retiree accesses their pension for the first time and pays an emergency rate of tax.

In the previous quarter (April to June), HMRC paid out an even higher £57 million, with more than 16,000 reclaim forms processed.

About £1.3 billion has now been reclaimed by people overtaxed on pension withdrawals since 2015 when pension freedoms came into effect. The freedoms mean retirees do not have to buy an annuity and are free to take either a regular income from their pension pot or ad-hoc withdrawals as they please.

Helen Morrissey, head of retirement analysis at the investment platform Hargreaves Lansdown, says being overtaxed can cause pensioners “huge problems” and that a “tax nightmare” is not a good way to start your retirement.

She adds: “More than nine years after pension freedoms it is inconceivable to think that people are still being overtaxed on their first pension withdrawals. Many of these people will not have been expecting this, and will have had a nasty shock when their tax bill was way higher than expected.”

While the amount of tax reclaimed has fallen compared to the previous quarter, experts fear that we could see a jump in the next set of data due to worries around next week's Budget.

Jon Greer, head of retirement policy at the wealth manager Quilter, comments: "What’s particularly concerning is that we may see a sharp rise in withdrawals, driven by growing anxieties surrounding the upcoming Budget. With persistent rumours and the government’s rhetoric pointing to a ‘painful’ fiscal event, many savers may take tax-free cash from their pension pots, fearing potential changes to pension taxation. This could lead to hasty decisions, which may not be in their long-term financial interests."

Why are savers overtaxed on pension withdrawals?

Pension savers are allowed to take money out of their self-invested personal pensions (Sipps) and workplace schemes as they wish from age 55 (rising to 57 in 2028). So, for instance, they could withdraw £500 one month, £1,500 the next month, and nothing for the rest of the year.

Pension withdrawals are subject to income tax, bar the 25% tax-free cash. HMRC taxes the first flexible withdrawal someone makes in a tax year on a “Month 1” basis. This means the amount withdrawn is taxed as if that will be the pension saver’s income every month for the rest of the tax year. In other words, a lump sum withdrawal is treated as though you will take the same income every month.

While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal will likely be left out of pocket.

A Freedom of Information request lodged, earlier this year, by the insurer Royal London revealed that hundreds of retirees have been overtaxed by more than £15,000, with some having to apply for refunds worth a staggering £50,000.

Greer comments: “The tax system's inherent flaws place a heavy burden on retirees. The PAYE system, while effective for regular income, struggles to accommodate the way pensions are accessed under the freedoms introduced in 2015.

“Until the system is changed, we are likely to continue seeing many savers caught out and forced to reclaim significant sums of money.”

How can retirees avoid being overtaxed? 

One way to avoid being overtaxed and having to apply for a refund is by making your first pension withdrawal a small one, if possible.

This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.

How can pensioners claim a tax refund?

If you are hit with emergency tax, you can complete a form and apply for a refund, or wait for HMRC to put you in the correct position at the end of the tax year.

• If you are taking only some of your pension pot, you should fill out the P55 form.
• If you are taking the whole lot, and have no other income sources for that tax year, fill out P50Z. If you do have another income, complete form P53Z.

Refunds are usually paid within 30 days and are sent directly to your bank account.

Note: if you are taking a steady stream of income via drawdown then you shouldn’t need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year, you are taxed the right amount.

Prime minister Keir Starmer has previously warned that the upcoming Labour Budget will be “painful” and involve “difficult decisions”, prompting weeks of speculation that pension tax relief could be cut. 

But a report from The Times this weekend said Labour is expected to abandon its plans after senior Treasury officials told the chancellor the policy would hit public sector workers on "relatively modest incomes". 

Under current rules, savers are entitled to tax relief on money they pay into their pension pot up to an annual maximum. This is essentially a refund at your marginal rate. If you are a basic-rate taxpayer, you get 20%, while higher and additional-rate taxpayers are entitled to 40% and 45% respectively.

The policy is a generous perk which encourages retirement saving but critics argue it is unfair, with a higher rate of relief going to those on higher salaries.  

It also comes with a hefty price tag – pension tax relief cost the government £48.7 billion in 2022/23, according to the latest HMRC data, with almost two-thirds of this sum enjoyed by higher and additional-rate taxpayers. 

Before this weekend's report in The Times, many were concerned that the cost of the policy would highlight it as a potential target for Rachel Reeves as she looks for ways to plug a £22 billion hole in the public finances. But cutting pension tax relief for higher earners isn’t as simple as it might sound. 

The way many schemes are set up means the only way for Labour to reduce the relief for higher earners would be to apply a tax charge. This shift could prove unpopular and risk alienating public sector workers on final salary pension schemes, among others. 

This move would also be counterintuitive given the government has just offered public sector workers a pay rise in an attempt to end industrial action. 

Against this backdrop, we take a closer look at pension tax relief. How would a rule change impact you and is it really off the table?

Pension tax relief: what would a change of rules look like?

If the government did decide to cut pension tax relief for higher earners, one option would be to introduce a flat rate of relief for all savers, say 30%. This would increase the amount of relief received by lower earners while cutting the perk for those on bigger salaries. 

The challenge with this is that it would be complex to implement. 

Tom Selby, director of public policy at AJ Bell, explains that there are two ways of receiving pension tax relief – “net pay” or “relief at source”. The latter wouldn’t be too challenging to deal with but the former would. 

A self-invested personal pension (SIPP) is an example of a “relief at source” scheme. With this, you typically receive the 20% relief from HMRC upfront and then claim back any additional entitlement through your tax return. 

If a flat rate of 30% pension tax relief was introduced, the government could implement this in "relief at source" schemes by reducing the amount higher earners were allowed to claim back in their annual tax return. 

In “net pay” schemes, though, pension contributions come from your pre-tax pay. This means higher and additional-rate taxpayers receive 40% or 45% relief automatically. As such, the only way for the government to reduce the amount of relief for these savers would be to apply a tax charge.

“If, for example, the government decided to set flat rate pension tax relief at 30%, anyone in a DB scheme earning more than £50,270 (the higher-rate income tax threshold) would be hit with a tax charge to reduce their automatic tax relief from 40% to 30%,” Selby tells MoneyWeek. 

He adds: “If a higher-rate taxpayer had paid a £10,000 contribution to a net pay scheme in the tax year, they would presumably need to pay a £1,000 tax charge to reduce their tax relief to the required 30%.

“Given public sector workers were up in arms over the impact of the lifetime allowance and annual allowance on their pensions, it’s hard to imagine hiking tax bills for all those saving in a pension and earning over £50,270 would go down particularly well.”

What other pension changes could appear in the Budget?

Cutting pension tax relief could prove too unpopular and complex to implement, but other pension changes could still crop up in the Budget, says Jason Hollands, managing director at wealth management firm Evelyn Partners. 

For example, some are concerned that Labour may change the rules on how much tax-free cash savers are allowed to withdraw from their pensions. Others have suggested the government could change inheritance tax rules to bring private pensions into scope. 

“The third way the government could generate increased revenues from private pensions would be to levy National Insurance Contributions on the payments employers make into employee pensions,” Hollands adds. “This could raise significant sums, even after netting off the impact on the extra cost for public sector pensions, without employees seemingly noticing any changes on their own wages.”

Finally, while it looks like Labour may have ruled out introducing a flat rate of pension tax relief, it could still consider cutting the annual tax-free pension allowance. 

Under current rules, savers can stash up to £60,000 in their pension pot each year (including employer contributions) while still benefitting from tax relief. But cutting this allowance could be another way for the government to raise revenue.

All will be revealed when Reeves delivers her Budget later this month on 30 October.

This article is out-of-date. Please see our newer article on this topic: What is the 25% pension tax-free cash - and when should you take it?

The Labour government is rumoured to be considering slashing the maximum tax-free cash that pension savers can take from their pots.

The popular pensions perk allows savers to withdraw 25% of their nest eggs tax-free, up to a limit of £268,275.

Chancellor Rachel Reeves could potentially make an announcement in the Autumn Budget on 30 October.

The Telegraph has reported that government officials have asked one of Britain’s top pension providers to assess the impact of cutting the tax-free lump sum to £100,000.

Both the Institute for Fiscal Studies (IFS) and the Fabian Society have argued that the allowance should be reduced to £100,000 because the current cap favours the wealthy.

There is also speculation that Labour could reduce the 25% tax-free cash amount to, say, 20%. And that the Budget could introduce a flat rate of pensions tax relief - but Reeves has reportedly shelved this idea.

Ian Price, a pensions expert and director of Price Consultancy, tells MoneyWeek that he is aware “that some individuals have taken their tax-free cash just in case something should happen”.

Pensions are an easy target for governments to tinker with and raise much-needed cash. The lifetime allowance, annual allowance and even the state pension triple lock have been chopped and changed over the past few years in a bid to save money.

However, any move to slash the pension tax-free cash could be seen as another attack on pensioners after Rachel Reeves’s winter fuel payments raid.

We look at whether the government is likely to tinker with tax-free cash.

Could Labour change the pension tax-free cash?

Tax-free cash - or pension commencement lump sum in the official jargon - is one of the most popular aspects of the pension system and a key reason why saving within a pension is advantageous from a tax point of view.

While pension savings are normally subject to income tax when withdrawn, a quarter of the pot can usually be taken tax-free.

During the election campaign, Sir Keir Starmer was asked about the future of tax-free cash and he replied that the current system would be reviewed in the coming years, were he to win the election.

However, Labour spokespeople then said he had spoken in error, and that the tax-free lump sum was here to stay.

Having said that, there have been no assurances since Labour got into power. And Starmer and Reeves have repeatedly warned that "difficult decisions" will have to be made, due to Labour inheriting a projected overspend of £22 billion from the Conservatives.

Becky O'Connor, director of public affairs at the pension provider PensionBee, comments: “The tax-free lump sum element to pensions is popular and one of the most universally well-understood benefits of a pension. Because of its popularity, making it less generous would be a risk.

“Options might be to change the percentage from 25% to say, 20%, or to change the maximum, which has been fixed at the same level despite the lifetime allowance being abolished and so now seems quite arbitrary.”

Price agrees that slashing or axing tax-free cash would be risky, saying: “I think it would be a very brave government that would reduce the tax-free cash on pensions.”

Could the maximum tax-free cash limit be lowered?

While the policy of taking a quarter of your pension tax-free may be maintained, the government could choose to reduce the maximum tax-free amount (£268,275) that savers can take.

The Telegraph suggests reducing the limit could raise around £2 billion in revenue at the Budget. Cutting the allowance to £100,000 could affect one in five retirees, according to the IFS.

Hargreaves Lansdown says those with a pension pot of £400,000 or more would be impacted, with savers facing a tax bill of up to £67,310.

Helen Morrissey, head of retirement analysis at the investment platform Hargreaves Lansdown, explains: "The immediate cost to those retiring will be income tax on up to £168,275 (£268,275 – £100,000), a cost of £67,310 if taxed at higher rates, or £33,655 if taxed at the basic rate."

She adds: “The chancellor may have said rumoured changes are designed to hit ‘those with the broadest shoulders’ but changes to the tax-free lump sum would do irreparable damage to the pension system. This risks undermining confidence and impacting people’s retirement savings."

Claire Trott, divisional director for retirement and holistic planning at the wealth manager St. James’s Place, warns that speculation around a reduction to the maximum tax-free cash allowance is "driving behaviours, which could result in people withdrawing excessive funds from pensions, potentially risking reduced retirement incomes".

She adds: "Moving money from a tax-privileged environment into one where growth and income are taxed, and potentially pushing estates into inheritance tax liability, can have significant implications".

Should I take my tax-free cash now just in case?

This is a risky strategy. No one knows exactly what Reeves will announce until she stands up and delivers her speech on 30 October.

While topping up your ISA could be a sensible move in the run-up to the Budget, as saving more is generally sound financial advice plus you can take the money out if you need it, experts caution against taking your tax-free cash purely to avoid a Labour tax grab.

This is because pensions offer a valuable tax shelter. If you take out your money, where will you put it? If you park it in a savings account or investment account, it will liable for tax.

In addition, under current rules, pension savings are usually free of inheritance tax – but this is not the case with money in ISAs, investment accounts or savings accounts so there’s the chance that taking your tax-free cash now could land your family with a nasty tax bill in future.

And don't think you can withdraw the cash "just in case" and then if nothing is announced at the Budget, pay it back into your pension.

There are rules in place to prevent savers taking out tax-free cash and then reinvesting in their pension (known as recycling). Those caught by recycling rules will be taxed at up to 55% of their tax-free cash amount.

We explore this further in Pension moves you should make before Labour’s Budget raid.

Will Labour reintroduce the lifetime allowance?

When former chancellor Jeremy Hunt scrapped the lifetime allowance on pensions, Labour was quick to announce that they would reintroduce it if they won the general election.

However, the party then backtracked on these plans. As a reminder, the lifetime allowance is a cap on how much savers can stash in their pension pot before they are subject to tax of up to 55%.

But could the government reintroduce it? There was no mention of the lifetime allowance in the manifesto, suggesting Labour may be trying to keep its options open.

“It seems unlikely that with the lifetime allowance now abolished and this complicated piece of pension tax legislation now dispensed with, Labour would reintroduce it, with all of the difficulties that would entail,” says O’Connor.

Savers have been refunded almost £1.2 billion in overpaid tax since pension freedom rules were introduced, government figures show.

A quirk in the tax rules when it comes to accessing retirement funds under pension freedom rules means that savers can end up paying too much to HM Revenue and Customers (HMRC) when making pension withdrawals.

The latest HMRC data shows savers reclaimed more than £38 million in overtaxation on pension withdrawals between October and December 2023.

More than 12,000 reclaim forms were processed during the quarter, with an average reclaim of £3,216 and it takes to total amount of refunds for overtaxed withdrawals close to £1.2 billion since 2015.

Tom Selby director of public policy at AJ Bell warns that the true overtaxation number could be substantially higher. 

“In particular, people on lower incomes who are less familiar with the self-assessment process might be less likely to go through the official process of reclaiming the money they are owed,” he says.

“As a result, they will be reliant on HMRC putting their affairs in order.”

How can pension withdrawals be overtaxed?

Former chancellor George Osborne’s pension freedom rules were introduced in 2015, letting retirees access their pension pots with more flexibility beyond having to buy an annuity or enter drawdown.

It meant that any pension withdrawals, beyond the 25% tax-free lump sum, were taxed at each individual’s own tax rate.

But while this area of pensions was modernised, the tax system has failed to keep up.

When accessing money in your pension the first time or making a single withdrawal, HMRC divides your usual tax allowances by 12 and applies them to the withdrawal.

Selby warns this can hit hard-working savers with shock tax bills often running into thousands of pounds.

While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC in their tax code, anyone who makes a single withdrawal will likely be left out of pocket, Selby warns.

“We are approaching the 10-year anniversary of former chancellor George Osborne’s bombshell pension freedoms announcement at the March 2014 Budget,” adds Selby.

“While those reforms have been widely welcomed by savers, who now have total flexibility over how they access their retirement pot from age 55, the government’s own tax systems remain stuck in the dark ages.

“It is simply unacceptable that the government has failed to adapt the tax system to cope with the fact Brits are able to access their pensions flexibly from age 55, instead persisting with an arcane approach which hits people with an unfair tax bill, often running into thousands of pounds.”

How to get your money back if you are overtaxed

Getting your money back can involve a lot of administration.

It is possible to get a refund within 30 days, but only if you complete one of three HMRC forms to reclaim your money. Otherwise you have to wait on the kindness and efficiency of HMRC to repay you at the end of the tax year.

Which form you need to fill out will depend on how you have accessed your retirement pot:

• If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z,
• If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z,
• If you’ve only flexibly accessed part of your pension pot then use form P55.

This tax trap can also be avoided by thinking about how you access your pension.

“One way savers planning to take a single withdrawal in a tax year can potentially avoid the shock of a big overtaxation bill is by taking a notional withdrawal first,” says Selby. This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.

“Alternatively, you can fill out one of three HMRC forms and you should receive your tax back within 30 days. If you don’t do this, the Revenue says it will put you back in the correct tax position at the end of the tax year.”

Most people associate self-assessment tax returns with the self-employed, and think the deadline is in January.

But there are lots of other reasons why you may need to submit a tax return to HMRC - and there’s a deadline in October too.

Anyone who needs to register for self-assessment for the 2024-25 tax year must do so by 5 October 2025. The deadline to then file a tax return online and pay any tax owed is 31 January 2026. Taxpayers who make payments on account make a second payment by 31 July every year.

About 12 million people file a tax return each year, and 97% of customers do so online. There is an earlier deadline of 31 October for those submitting a paper tax return.

“Self-assessment angst usually strikes in January, but there are some people who need to get their skates on well before that, because they need to register for self-assessment before the deadline on 5 October. Those who have started a business or partnership are likely to be well aware of this, but there are other groups of people who may have no idea they need to sign up for the first time,” comments Sarah Coles, head of personal finance at Hargreaves Lansdown.

As HMRC puts it: “New self-assessment customers could be someone who has set up a side hustle to earn money in addition to their PAYE job or disposed of crypto assets; they may be newly self-employed or a new landlord renting out property. Whatever the circumstances, if a customer has any income that they have not already paid UK tax on, they need to register for self-assessment.”

HMRC recently put out a warning urging “side hustlers” to register for self-assessment. "Whether you are selling handmade crafts online, creating digital content or renting out property, understanding your tax obligations is essential. If you earn more than £1,000 from these activities, you may need to complete a self-assessment tax return,” explains Myrtle Lloyd, HMRC's director general for customer services.

Even if you don't owe any tax, you may still need to file a return to claim a tax refund, claim tax relief on business expenses, charitable donations, pension contributions, or to pay voluntary Class 2 National Insurance contributions to protect your entitlement to certain benefits and the state pension.

Here are 11 reasons for registering, from the well-known, such as becoming self-employed or a buy-to-let landlord, to more surprising, lesser-known, reasons.

Note that the list isn’t exhaustive, there are plenty more reasons for filing a self-assessment return, due to our complex tax regime! You can use HMRC’s online checking tool to assess whether you need to complete a tax return.

1. You work for yourself or you’re in a business partnership

As you don’t pay income tax through PAYE, you need to tell HMRC how much you earned and then pay any tax via self-assessment. You will likely have to make two payments each year, one by 31 January and the other by 31 July.

2. You’re a buy-to-let landlord 

If you’re earning money through renting out a property, or several properties, you need to tell HMRC so you can pay the correct amount of tax on this income.

3. You’re a higher-rate taxpayer who pays into a pension 

If you pay into a personal pension like a Sipp, or your employer runs a scheme on a “relief at source” basis, you’ll get basic-rate tax relief and need to claim the rest from HMRC. Higher-rate taxpayers can claim an extra 20% while additional-rate payers can get a further 25%.

If your employer makes contributions before tax (known as “net pay”), you’ll receive the full pension tax relief automatically and you don’t need to tell HMRC. The same is true if you have a salary sacrifice arrangement. If you’re not sure how your workplace pension works, check with your HR team or your pension provider.

If you have extra relief to claim, you can either complete a tax return, or if you’re employed you can write to HMRC and receive a one-off payment. Coles notes: “However, if you opt for a letter you’ll need a new one every time your salary or contributions change significantly, which might actually end up taking more effort.”

4. You’re a higher-rate taxpayer who gives to charity 

You automatically get 20% gift aid when you donate to charity, but you can claim back the rest of the tax relief through a self-assessment claim.

However, if this is your only reason for completing a tax return, there are alternatives. You can fill in a separate form to make the claim, or contact HMRC and ask them to amend your tax code instead.

5. You receive child benefit and you or your partner have an income above £60,000 

This means you’re subject to the high income child benefit tax charge. For the 2023-24 tax year, this kicks in at £60,000 annual earnings, and means you have to repay 1% of the benefit for every £200 you earn over the threshold.

The £50,000 threshold for child benefit rose to £60,000 in April last year, and the top of the taper rose from £60,000 to £80,000. So, some good news for parents for the 2024-25 tax return.

There’s more good news if you pay income tax through PAYE. In future, parents will be able to pay the child benefit tax charge through their payslip, rather than doing it via self-assessment. There are more details about HMRC’s new service on gov.uk.

Bear in mind that once you earn above £80,000, you’ll need to repay all your child benefit, so most parents find it easier to claim it but tell HMRC not to make any payments – which saves the bother of repayment but means you still get National Insurance credits, which count towards your state pension.

6. You make more than £3,000 in capital gains 

Capital gains are the profits you make when you sell something that’s increased in value. It also applies if you give something away to anyone other than a spouse or civil partner during your lifetime, so even if you’re not personally making the profit, the tax is due.

The capital gains tax threshold for 2024-25 was £3,000. If you made more capital gains than this, you need to complete a tax return and pay capital gains tax.

7. You make a capital loss

This information also goes on your tax return. If you make a loss you can set it against other gains in the same tax year, or carry it forward to offset losses in a future tax year.

Note that if you’ve never made a capital gain and you don’t otherwise need to do a tax return, you can write to HMRC instead.

8. You make £10,000 in interest and/or dividends 

If you make money over your personal savings allowance (£1,000 for basic-rate taxpayers, £500 for higher-rate taxpayers and £0 for additional-rate taxpayers) or dividend allowance (£500 in 2024/25), you will usually have to pay tax, but if you’re employed you can ask HMRC to adjust your tax code to take the money.

If you have interest over your allowance, you’re not employed, don’t get a pension and don’t complete a tax return, HMRC will contact you at the end of the tax year with a tax demand, if applicable.

However, if you need to pay tax on over £10,000 in dividends, or your savings interest is £10,000 or more, you’ll need to fill in a self-assessment tax return.

9. You invest in an EIS or VCT 

Some investments like enterprise investment schemes and venture capital trusts come with tax benefits that you can claim via self-assessment. However, if this is your only reason for filing a tax return, you can arrange for the tax to be repaid through an amendment to your tax code.

10. You have a side hustle and make more than £1,000 a year 

Everyone has a £1,000 trading allowance, which can cover things like selling items through eBay or Vinted, or being paid to babysit or walk dogs. Any more than this and you normally need to do a tax return.

11. You rent out a spare room, and make more than the rent-a-room limit

You can make up to £7,500 a year tax-free by renting out a furnished room in your home, including through Airbnb. Any more than this, and you need to register for self-assessment.

TWO MORE SELF-ASSESSMENT TIPS 

If you think you no longer need to complete a tax return for 2024-2025, you need to tell HMRC before the deadline on 31 January 2026 to avoid any penalties or needing to complete a tax return. HMRC has produced two videos explaining how customers can go online and stop self-assessment if they are self-employed and those who are not self-employed.

Customers should be aware of the risk of falling victim to scams. Never share your HMRC log-in details with anyone, including a tax agent, if you have one. There is more scams advice on this HMRC page.

Pension savers risk losing thousands of pounds of tax-free cash due to lifetime allowance reforms that came into effect in April.

Savers typically receive 25% of their pension pot tax-free, but this could be reduced to just 10% over the next decade.

This is because a maximum limit of £268,275 tax-free cash was introduced in April. It was one of former chancellor Jeremy Hunt’s pension reforms. Back in last year's March Budget, he famously declared that the £1,073,100 lifetime allowance would be scrapped. The allowance is the amount you can put into workplace pensions and self-invested personal pensions (Sipps) without being hit with a tax penalty of up to 55% when you come to withdraw it.

But what many people did not notice was that the former Conservative government also set a maximum of 25% of the lifetime allowance (which was £268,275) as a limit on tax-free cash.

It means if your pension grows to £1.5m in the next few years, the cap on the tax-free cash will remain at £268,275, which is the equivalent of just 18% of the nest egg. 

The wealth manager Quilter calls it a “stealth tax”, and warns it will have “major consequences for those who, through careful financial planning, have accrued significant pension wealth”.

Roddy Munro, head of tax and pensions at Quilter, comments: “With savers already impacted by fiscal drag as well as the reduction in the capital gains annual exempt amount and the dividend allowance, now those with large pension funds will soon feel the full effect of the freezing of the amount they can take tax-free from their pensions.

“But people can act as there are a number of ways to avoid these Machiavellian reforms.”

It's possible that the goalposts on the lifetime allowance and tax-free cash could move again under the new Labour government. 

Chancellor Rachel Reeves could reveal changes to pensions in the autumn Budget on 30 October. This could include cutting pension tax relief, reintroducing the lifetime allowance, or lowering the amount of tax-free cash that can be taken - although these would all be very unpopular for older savers with large pension pots.

How fiscal drag affects pensions tax-free cash

According to Quilter, those who have reached or are set to reach the previous lifetime allowance will see the amount of tax-free cash available to them shrink in percentage terms and in purchasing power as their pension grows.

After a decade, assuming investment growth of 6% a year, a £1,073,100 pension would be worth £1,921,759. If the tax-free lump sum stayed at £268,275, a retiree could only withdraw 14% of their pension tax-free.

If you also factor in inflation at 3% a year, the value of the tax-free lump sum after a decade drops to £199,622, or just 10% of the retirement pot. 

Source: Quilter. *Assumes 6% annual investment growth. **Assumes 3% inflation.

How to beat the tax-free cash squeeze

About 1.6 million people are set to breach the previous lifetime allowance by 2026, with many more set to exceed it in the years to come.

Savers are being urged to take action over the fixed tax-free lump sum, or face a pension inertia trap.

A key consideration is at what point you decide to “crystallise” your pension. This occurs as soon as you withdraw money from it, such as your tax-free cash. 

If you crystallise your pension earlier than planned, there are two issues to be aware of. First, money that is withdrawn from a pension will lose its advantageous inheritance tax status. 

Second, you trigger the money purchase annual allowance (MPAA), which means the maximum you can contribute to your pensions in a tax year is slashed from £60,000 to £10,000 a year.

Some savers may wish to crystallise earlier than planned and invest their tax-free cash in other products to both protect and make their tax-free cash rights work harder. 

Munro explains: “Some people with larger pensions are deciding to take their tax-free cash earlier and utilise other products. Where this is the case, it is important people consider the likes of ISAs and insurance bonds to shield their long-term savings from the taxman should their pension be above the traditional lifetime allowance. 

"Insurance bonds in particular are back in vogue following these reforms as they can help to control the tax payable, simplify tax reporting and sit within a trust for inheritance tax planning purposes.”

Alice Haine, personal finance analyst at the investment platform Bestinvest, says that if savers take their tax-free cash early they need to consider carefully that they are giving up tax-free investment growth and the money will also be liable for inheritance tax.

Meanwhile, savers with defined benefit pension schemes may also be worried about the new tax-free cash rules. 

Munro notes: “These savers may have to consider more complex planning to protect their tax-free cash amount. The best outcome for consumers will very much be driven by their own and their family’s circumstances, so taking professional advice will be critical.” 

Pensioners have recovered millions from HMRC after being taxed too much when making flexible pension withdrawals in the last three months.

Pensioners reclaimed more than £48.5 million in overpaid tax on their pension withdrawals from 1 July to 30 September 2025, new data from HMRC shows.

The total number of retirees putting in a claim for tax repayment was 13,721 in the third quarter of 2025, 11% more than the 12,331 claims processed by HMRC in the same period last year.

The average amount of incorrectly levied tax returned to pensioners was £3,539 per person in the last quarter, down slightly from an average of £3,592 this time last year.

The risk presents itself when you first access your pension pot. HMRC taxes your first withdrawal on a ‘month one’ basis, meaning it assumes you will withdraw the same amount every month for the rest of the tax year. An emergency tax code is applied at this stage.

The problem is not everyone withdraws a regular income from their pension. Some savers decide to make a large one-off withdrawal at the start of retirement, or alternatively tap into their retirement pot as and when they need to.

HMRC will usually set things straight at the end of the tax year without you having to do anything – however there are steps you can take to get your money back more quickly, or to avoid being overcharged by a large amount in the first place.

The latest figures bring the total amount that retirees have claimed back from overtaxation to more than £1.5 billion since 2015, when pension freedoms and flexible pension withdrawals were first introduced.

This huge sum highlights the extent of the overtaxation problem with flexible pension withdrawals.

Jon Greer, head of retirement policy at Quilter, said: “A decade after the introduction of pension freedoms, it remains extraordinary that thousands of people are still being overtaxed every quarter simply for accessing their own savings. The system continues to work against the very flexibility it was designed to promote.

“Although HMRC has made changes to speed up repayments, these figures show the underlying problem persists. The PAYE system was built for regular employment income, not one-off pension withdrawals, and it continues to cause unnecessary complexity for retirees.”

These figures “are likely to only be the tip of the iceberg”, according to Tom Selby, director of public policy at AJ Bell, because the onus is on pensioners to recognise the overtaxation and fill out HMRC’s relevant reclaim forms

“In reality, many will be reliant on HMRC putting their affairs in order at the end of the tax year,” he said.

Why are pensioners overtaxed on withdrawals?

The reason so much tax is incorrectly collected from pensioners is because of the way HMRC calculates tax allowances.

HMRC taxes the first flexible pension withdrawal made in a tax year on a ‘month one’ basis.

“This means HMRC divides your usual tax allowances by 12 and applies them to the withdrawal, landing hard-working savers with shock tax bills often running into thousands of pounds," says Selby at AJ Bell.

“While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal will likely be left out of pocket.”

This issue has been exacerbated by increases to the state pension – the full new state pension now consumes almost all of the £12,570 personal allowance, which has been frozen since 2022 (a phenomenon known as fiscal drag).

Greer at Quilter says: “With the allowance frozen and the state pension rising each year, many people are being dragged into the tax net. When they make flexible withdrawals to top up their income, a larger portion is now taxable, compounding the frustration when over-deductions occur.”

What to do if you think you are owed money from pension overtaxation

If you are taking a regular stream of income through pension drawdown, you shouldn’t need to do anything. HMRC should adjust your tax code throughout the year to ensure you have paid the correct amount of tax overall.

If you make a one-off, ad hoc withdrawal, and think the taxman has taken more than needed, you can submit a form to reclaim the overpaid tax. You will need to select one of three forms.

The form you will need to fill out will depend on how you accessed your retirement pot:

• If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z
• If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z
• If you’ve only flexibly accessed part of your pension pot, then use form P55

These forms can be found on the government website.

Provided your request is genuine and HMRC works out they incorrectly taxed you, you will get your money back within 30 days.

If you believe you were taxed too much but do not fill out the relevant forms, you will be left relying on HMRC to repay the tax overpayment at the end of the tax year.

Selby at AJ Bell says retirees who take regular flexible pension withdrawals multiple times a year should not need to take any action as HMRC adjusts your tax code to ensure you are taxed correctly over the course of the year.

“However, if you make a single withdrawal then you will either need to fill out one of three forms or rely on HMRC putting you in the correct position at the end of the tax year,” Selby explains.

Will HMRC reforms reduce overtaxation?

HMRC updated its system from April 2025 to move savers onto the correct tax code more quickly.

Despite this, limitations mean the changes will only improve things for those taking a regular income. Those who make a one-off withdrawal will continue to be overtaxed.

Some experts believe the changes do not go far enough.

“We have only just blown out the candles on the cake celebrating 10 years of pension freedoms,” said Tom Selby, director of public policy at investment platform AJ Bell. “It is simply unacceptable that after all this time, the government has still not managed to adapt the tax system to cope with the fact Brits are able to access their pensions flexibly from age 55.”

Thankfully, there are some steps savers can take to reduce the impact of a shock tax deduction. For example, experts often recommend making a small withdrawal first. HMRC should then apply a more appropriate tax code to any subsequent larger withdrawals.

Taxpayers who find themselves submitting a reclaim form for a large amount of money may not have been aware of this tip.

For example, some of the savers highlighted by Royal London reclaimed more than £100,000 in overpaid tax in 2023/24. To generate an emergency bill of this size, they would need to have withdrawn more than £300,000 when first accessing their pension.

Savers do ultimately get this money back from HMRC. Even if they don’t actively claim it, things should get settled up automatically at the end of the tax year. Despite this, delays (or alternatively form filling) can be inconvenient and disrupt your immediate plans.

“Suddenly, that large chunk of money which had been earmarked for something special, like a new kitchen or the holiday of a lifetime, has shrunk considerably, and in some cases these plans may have to be postponed or abandoned altogether,” said Clare Moffat, pension expert at Royal London.

“If these withdrawals are being made to help children or grandchildren get a foot on the housing ladder, then the effect can be to derail a home purchase at the last minute when it’s discovered that the money required to complete the purchase has suddenly been eroded.”

For many savers, being able to take 25% of their pension savings as a tax-free lump sum when they reach retirement is one of the main attractions of private pensions.

While there are many potential uses for this money – from paying off a mortgage, helping grown up children or spending it on travel – you don’t have to take it all at once. In fact it may make sense to opt for instalments instead.

For one thing, money left in your pension fund can continue to be invested. If you withdraw 25% of your pension savings, you're immediately reducing the value of your pension pot and taking away the chance for that money to grow further.

Plus, if the investment markets have been volatile and reduced the value of your pension, leaving some of those savings invested could mean they benefit from any future recovery, and mean you are better off overall.

Equally, by taking your tax-free cash in instalments, rather than upfront, you can use it to supplement your pension income. This may be useful for younger savers waiting for state pension benefits to become available, for example, or simply for anyone anxious about making ends meet.

Another benefit of staggering your tax-free cash is that money taken out of your pension is considered part of your estate for inheritance tax (IHT) purposes.

Savings inside a pension plan, by contrast, can generally be passed on to your heirs with no IHT liability to worry about. If the inheritance tax bill is a potential problem for your family, that may be very valuable.

However, rules surrounding pensions and IHT will change in 2027. In her Autumn 2024 Budget statement, Chancellor Rachel Reeves announced plans to include unused pensions and certain death benefits in the value of a person's estate, for the purposes of inheritance tax. This rule change will take effect from April 6, 2027.

Taking a pension lump sum in instalments: how to organise your pension

If you plan to take your tax-free pension lump sum in instalments, there are a few different ways to organise your pension income. It’s worth highlighting that taking independent financial advice on the best option will make sense for most savers.

The simplest route is to leave your pension ‘uncrystallised’. This simply means you’ll take money directly out of your savings, rather than structuring withdrawals through an income-drawdown plan or an annuity purchase.

Each time you make a withdrawal, 25% of it will be covered by your entitlement to take 25% of the fund tax-free, so there will only be income tax to pay on the other 75%.

The alternative is to use a more conventional drawdown arrangement – known technically as ‘flexi-access drawdown’ – but stagger the transfer of your savings into the scheme. Each time you need some money from your savings, you take a tax-free lump sum directly from your remaining pension fund.

Then, for each £1 taken, you must move £3 into the drawdown plan. You’ll only pay tax on this cash when you withdraw it from that fund. You can keep doing this until you’ve exhausted the funds in your original pension plan.

Is it worth taking my tax-free pension lump sum in instalments?

There are pros and cons to each of these methods for taking your tax-free pension lump sum in instalments. The right option for you will depend on your individual circumstances.

But either way, there’s a good chance you’ll ultimately get access to more tax-free cash than you would have been entitled to by taking the full 25% entitlement upfront. If your pension fund continues to appreciate, so will the cash value of the tax-free portion of it.

Be realistic, however: turning down your upfront tax-free cash may well be a luxury you can’t afford. If the full 25% lump sum is part of your financial planning arrangements as you move into retirement, you’ll need to take it or change your plans. However, if you can afford to do without the full lump sum in one go, instalments have real advantages.

Does tax-free pension lump sum count as income?

No, it’s tax-free.

You'll pay income tax on the remaining 75% of your pension pot, however. The amount of tax you pay depends on your income tax band for that year.

Your pension provider will take any tax from your drawdown income payment before it’s paid out.

How to take a tax-free lump sum from a pension

If you have a financial adviser then this practical side of things can be taken care of by them on your behalf.

If you’re handling your retirement arrangements yourself you can speak to your pension provider directly about accessing your money.

“For defined contribution schemes there’s UFPLS – uncrystallised funds pension lump sum,” says Laith Khalaf, head of investment analysis at AJ Bell.

“This is a cash withdrawal from your pension scheme, 25% of which is tax free, and the rest stays put.

“Alternatively you can buy an annuity and take your 25% at this point. Or go into income drawdown where you can take some or all of the tax-free money and leave the rest invested while taking an income – large or small. You could also do a mix of the two.”

Whatever you decide, your provider will tell you what you need to do which might be as simple as filling out an online form. The process will vary between providers.
Remember, you can only do this once you’ve reached the age of 55 (rising to 57 from April 2028).

Final salary schemes also known as defined benefit, typically pay a scheme pension, which is a pre-determined income for life, plus a pre-determined tax-free lump sum.

Khalaf adds: “There is normally a scheme retirement age and the payment would only get automatically triggered at that point. If you retire before this date it may be possible to take your pension earlier but with a reduced income.

"Conversely if you retire later some schemes may let you continue to roll up your pension beyond the scheme retirement age and build up further benefits.” You’ll need to speak to the pension scheme department.

How much can I take from my pension tax-free?

Typically you can take up to 25% of your total pension savings tax-free.

There are limits in place – the most you can take is £268,275, though your tax-free amount may be higher if you hold a protected allowance. These limits won’t affect most savers – they apply to those with pension pots upward of £1 million. The average pension pot in the UK is around £20,000, according to PensionBee.

There are some exceptions for the 25% limit. Some old-style workplace pensions with ‘protected tax-free cash’ might allow you to take a higher proportion than 25%. You’ll need to speak to your scheme provider about this.

You may be able to take all the money in your pension as a tax-free lump sum, if you’re terminally ill. To be eligible you should be expected to live less than a year because of serious illness, be under the age of 75 and for the amount to be below your lump sum and death benefit allowance.

Is the 25% tax-free pension lump sum under threat?

Since this pension perk is so valuable, there is often talk that it could be changed or removed entirely.

Most recently there were rumours that the pension tax-free lump sum was under threat in the run up to Labour’s first Budget in October 2024.

It’s important to remember that tax rules and allowances can and do change over time so it’s important to maximise them while they are around.

Beware of pension scams

Fraudsters often target people planning to withdraw money from their pension so be wary of any cold callers offering their services. Scams include a cold caller claiming to know about loopholes that can help you get more than the usual 25% of your pension pot tax-free. As part of this scam they might persuade you to transfer your pension to them which can lead to losing your life savings overnight.

Many fraudsters clone the websites of genuine pension firms and extract money by pretending to be part of that firm and offering to take charge of their pension savings.

Some might also promise to help you take your pension savings before you reach 55.

Since January 2019, there has been a ban on cold calling about pensions so unless you’ve asked someone to contact you, any caller is likely to be a fraudster.

Remember, don’t be pressured into making any decisions – alarm bells should ring if someone tries to rush you into agreeing to something.

Take time with your pension planning and if necessary enlist the help of a professional adviser. You can find one in your area at unbiased.com.

How the Conservative party has changed. When he was chancellor in the 1980s, Nigel Lawson took pride in abolishing at least one tax every year. Now, in the run-up to Rishi Sunak’s first Budget, the press has been filled with presumably well-founded speculation about tax increases.

The prime target for the media pundits is the dwindling array of tax breaks available for pension-fund saving. In 2014, Lib Dem pensions minister Steve Webb persuaded a sceptical George Osborne to free pensions from the stringent restrictions they were subject to. Ever since, Conservative chancellors have been chipping away at tax reliefs on pensions as if to reverse the incentive to save that was then provided.

The lifetime allowance, first introduced in 2006, limited the value of an individual’s pension fund. Above that limit, a penal rate of tax of 55% is applied either on drawdown, at the age of 75, or, for members of defined-benefit (DB) schemes, as the limit is exceeded.

The allowance was progressively reduced from £1.8m in 2011/2012 to £1m five years later. Though it has since been raised to £1.055m, there is no shortage of advocates for slashing it further, even though the current limit is causing significant problems for the NHS, whose senior doctors and surgeons are finding that their net pay from extra shifts is more than swallowed up by the pension tax.

The lifetime allowance is a tax on successful investing

The justification for this limit is to restrict the tax relief on pension contributions but, in reality, it is a tax on investment returns. Pay £30,000 a year into a pension fund for 35 years and you will not be liable for tax at 55% if your investment return is zero, but pay in just £10,000 a year with an investment return of 10% per annum and your tax liability will exceed £900,000. All the benefit you had from the exemption of your fund from income and capital-gains tax will be more than clawed back.

In 2011 the chancellor went further, limiting tax relief on contributions to £50,000 a year, reduced to £40,000 three years later. This might seem generous, and it is for those such as higher-grade civil servants whose pay rises steadily over a lifetime. Those with family commitments or erratic earnings often cannot afford to contribute every year, but do so from windfalls or when they can. They are penalised, as are high earners, whose limit is just £10,000 a year.

The next target of the lobbyists for more taxation is the higher-rate tax relief on pension contributions, on the pretext that higher-rate taxpayers account for more than half the total cost of the tax break.

This ignores the reality that the tax relief is no more than tax deferral. Pensions are a system for converting capital, which is not taxed, into income, which is. Tax at both the standard and higher rate is payable on pension incomes, so stopping full tax relief on pension contributions would amount to double taxation, as would levying capital gains and income tax on pension-fund returns.

How to spread the benefit

There are much better ways to spread the benefit of the tax relief more widely. Auto-enrolment in the expanding National Pension Scheme (NPS) will help, as would raising the threshold for higher-rate tax.

The value of the tax relief to standard-rate taxpayers has come down with the tax rate, but it doesn’t have to be so limited; tax relief could be granted to standard-rate taxpayers at a rate of 25% or 30%. And if people are expected to become more reliant on the NPS and less on the state pension, shouldn’t the rate of employee’s national insurance be cut? It was just 6.5% when Lawson was chancellor, but is now 12%.

The objection is that the government can’t cut taxes because it has to fund monstrously extravagant and pointless infrastructure projects such as HS2. People supposedly want higher taxes to pay for higher government spending, but I don’t believe it, not even when the tax is targeted at the better-off. People realise that governments that start raising taxes on the few soon raise them on the many.

Pension funds are the primary source of long-term savings in an economy, vital to fund the long-term investment on which economic growth depends. Yet the government seems determined to continue chipping away at incentives to save for retirement. Having abolished higher-rate tax relief, will it go on to abolish the current entitlement to withdraw 25% of a pension entitlement tax-free? Will pension funds be sequestered to finance low- or zero-return infrastructure projects favoured by government? Will defined-contribution (DC) schemes suffer the same fate as DB ones? Pension savers need long-term certainty and the economy needs pension savings.

I’ve just taken six weeks off. Perhaps you noticed? I spent most of it dealing with a 20-year build-up of boring but probably important admin (I didn’t change energy supplier, but I did discover the passwords to my children’s Junior Isas). Last week, I gave myself a partial reward in the form of a family ski trip – one which has transitioned me neatly back to the subjects I think about for you.

On several ski lifts I sat next to a firefighter. Really nice woman, but meeting her stirred unattractive feelings of resentment in me. She was younger than I am, but while I feel mid-career, she was already planning her public sector, defined-benefit-pension-financed retirement. She’s thinking of the lump sum. The regular inflation-adjusted income for ever. The joy of knowing that it is just going to keep coming in every month while she thinks about what she might do next.

I don’t begrudge the early security. It might be an expensive remnant of the pre-breathing equipment days when firefighters didn’t end up with a particularly long or pleasant retirement. But it was also the deal when she signed up for the job.

The pensions system is breeding resentment across the nation

Even so, our conversations – followed by a few vital lifts at the resort being closed as a result of gilets-jaunes-supported strikes (cue weeping children and a long trudge back to the hotel) – reminded me just how angry absolutely everyone everywhere is about pensions.

In the UK, anyone with a defined-contribution (DC) pension is irritated by the hugely more generous tax treatment of defined-benefit (DB) pensions. Anyone with a DB is maddened by the inheritability of DC pensions.

Anyone with a DB is equally maddened by the idea they might be asked to move to a DC (this is why staff at 74 UK universities are now on strike).

Anyone running or acting as a trustee of a DB is horrified by the way super-low interest rates have created pension-fund deficits. Anyone running a company with a legacy DB scheme is stunned by the level of cash they have to shovel into those same deficits (there is even evidence that they pay lower wages as a result).

Everyone in higher tax bands is cross about the way the annual allowance and the lifetime allowance limit their tax relief opportunities. And of course the younger you are, the crosser you are – before 2006 there were no limits on pension tax relief (bar an annual restriction to a percentage of your income). Today you can’t save more than £40,000 a year or £1.055m over a lifetime and even those simple sounding allowances can descend into admin hell in the blink of an eye. Pensions taper, I am thinking of you.

The point of pensions tax relief

But in all this sound and entitlement fury, I suspect we are forgetting the key point of pension tax relief. It isn’t to get you that Lamborghini or to pay for whatever the annual equivalent of a Caribbean cruise is going to be in our new virus-ridden world.

It’s something much more boring. It’s to keep you out of the means-tested benefits system. To stop you being a burden on other taxpayers in your retirement. That’s it. Anything you save above the level required for that is simply a drain on the public finances – and hence other taxpayers.

How much tax relief should you, then, get? I thought I’d work this out by looking at how much the UK benefits system reckons a retired person needs to live. The answer points to around £16,000 to £17,000 per year.

If you are in your 70s, live on your own and have no assets or income of any kind whatsoever, that’s what your total benefits package could come to (check out the calculator on the entitledto.co.uk website).

Most of this will come from the state pension (the full state pension is now nearly £9,000 per year) but, depending on your circumstances, could be topped up by other forms of state help such as housing benefit, council tax credit and pensions credit.

If we assume that most people will now end up with a full state pension (35 years work) that means that the state needs everyone to have a pension pot that will provide around £10,000 of income annually. Assume a 3% yield and that’s only a £300,000 retirement pot – a level most people auto-enrolled into a pension scheme from the age of 22 should reach.

The current tax relief system is ridiculously generous

Look at it like that, and the current system with its lifetime allowance of over £1m seems ridiculously generous. And scrapping the higher-rate tax relief system – as it is rumoured the next Budget will address – isn’t spiteful, self defeating, an act of fiscal hooliganism or part of a war on wealth. It is just a way to prevent the better off effectively hypothecating their own tax revenues back to themselves.

Think of it as less an unkindness than a rational response to a rising level of state pension entitlement and a need to deploy tax revenue elsewhere – or, in my dream world, to find a way to cut taxes.

It isn’t entirely straightforward – this kind of change is hard to implement in the public sector in particular. But unless we dump the relief system altogether (perhaps in favour of a much higher state pension) or shift to a pure Isa-style system for pensions, it is definitely coming.

With this changing dynamic in mind it is time for the better off to recalibrate. Stop thinking of your tax relief topped-up pension pot as a God-given route to grey gold or your primary source of retirement income. Instead, start thinking of it as an insurance policy – there to provide a base income and a back up if all else goes wrong.

The rest needs to come from savings made elsewhere, because contrary to popular belief, just as it is possible to give to charity without other taxpayers having to finance your Gift Aid, it is possible to save for retirement without a pension wrapper.

None of this works for my own finances by the way. My admin marathon has made it clearer than I would like that I am far, far from retirement. So I would much prefer a world in which I got unlimited tax relief on my pension contributions, retired in the next decade on the proceeds with a wave of thanks to lower earning taxpayers and joined my nice firefighting friend on a long yoga retreat. But that wouldn’t be right, would it?

• This article was first published in the Financial Times