NEW UK PENSIONS TAX

City AM reports (August 21, 2025):

Tax-free pension lump sum could be slashed to fill Labour’s black hole

By: Simon Hunt City Editor

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Tax-free lump sum withdrawals from pension pots could be slashed as Rachel Reeves scrambles for fresh ways to plug a £50bn hole in the public finances.

The Chancellor is reportedly eyeing a cut to the amount of money pensioners can withdraw from their savings pot without paying tax to as little as £40,000.

That would mark a major raid on the pensions rules, which at present allow as much as 25 per cent of pots up to a cap of £268,000 to be withdrawn tax free.

The move would be expected to raise more than £2bn for the Treasury, as Reeves searches for ways to raise tax receipts without breaking Labour manifesto commitments.

The Treasury has not denied that the tax change was under consideration but told the Telegraph the Chancellor was not prioritising pension reforms and thought it was “unlikely”.

A raid on pensions is one of several fresh taxes Reeves is thought to be mulling, including a “mansion tax” on homes worth more than £1.5m, as well as a tightening of inheritance tax rules.

‘There didn’t seem to be a plan on the table’

Economists have predicted the Treasury will need to raise as much as £50bn in extra taxes to stay within its fiscal rules, laying bare the scale of the pain that could be wrought on businesses by Rachel Reeves in the autumn.

The government is set to miss its “stability rule” by as much as £41.2bn by 2029-30 on top of having to maintain its £9.9bn “wafer thin” fiscal headroom, according to a report by the National Institute of Economic and Social Research, with economists adding that there was no way such huge sums could be raised without Labour breaking its manifesto commitment not to increase taxes on working people.

SOCIAL CONTRACT AND MANIFESTO PLEDGES

UK’s Labour government stresses repeatedly that it wishes to remain firm to its election Manifesto commitments.

As the TransAmerica Institute states:

The idea of a ‘social contract’ has been central to retirement systems in many countries around the world.

A social contract is an arrangement involving three pillars (commonly referred to as a 'three-legged stool' in the U.S.) including governments, employers, and individuals – each with a specific set of expectations and responsibilities.

In the last century, when these social contracts were created, they emphasized government and employer retirement-related benefits and, to a lesser extent, the need for personal savings. When these retirement systems were created, life expectancies were typically 65 years for most workers, which also happened to be the age of entitlement. Since then, the age of entitlement has remained largely unchanged, but life expectancies have increased significantly in most countries.

Today, due to increases in longevity and population aging, government-sponsored retirement benefits are under severe financial strain. Traditional defined benefit pension plans offered by employers are disappearing and being replaced by employee-funded defined contribution retirement plans. With these shifts, individuals are expected to take on increasing risk and responsibility for self-funding a greater portion of their retirement. However, many are inadequately equipped to successfully to do so, and many are therefore at risk of not achieving a financially secure retirement.

UK workers have for generations made a deal – a social contract – with Govt UK:

· Workers and their employers fund retirement plans

· The State gives tax exemption

· Which is clawed back through costs for old age care

· Reducing the welfare burden on the state.

Now Govt UK is – yet again – changing the terms of the Retirement Social Contract. So, workers and employers will be discouraged from placing further funds in retirement plans.

There are other opportunities for workers and employers to save long-term money in trust, outside of retirement plans under the control – and changing deal terms – of the UK government.