Moving to flat rate tax relief on employee pension contributions, capping the PCLS at £100,000, introducing NICs on employer pension contributions – all changes to pensions tax rumoured to be under consideration over the past few weeks as part of the Chancellor’s first budget.  In the end the changes when they came were less wholesale – for which a pensions industry still unravelling the complexities of the last great pensions tax change (the abolition of the lifetime allowance) will no doubt be grateful.

Indeed, at first blush the headline pensions announcement seemed relatively benign – a move to close what the Chancellor referred to as a “loophole” and bring pensions death benefits within the Inheritance Tax regime.  However, the consultation on implementing the change which followed swiftly after Rachel Reeves’s speech suggests the changes will be more fundamental than anticipated, looking to harmonise the tax position for death benefits across UK pension schemes.

And the broader implications of some of the Chancellor’s wider changes will have significant implications for the pensions industry – these include increases to employer National Insurance Contributions (NICs) and to the national minimum wage.

What are the headline pensions tax changes?

The key “pensions tax” measure in the budget was the move to bring unused pension pots within the IHT regime.  The budget itself is light on detail as to what this will actually involve – the key section says:

“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. 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.” 

Currently, and up to 5 April 2027, unused DC pension pots benefit from favourable tax treatment (survivors only pay income tax when accessing the unused pot where the member died on or after reaching age 75).  The tax treatment of survivor pensions and lump sums from DB schemes is different, but also not currently subject to IHT.  The reference to the 2015 pension reforms initially suggested the change to bring unused pots within an individual’s estate for IHT purposes may be limited to DC schemes.

However, alongside the budget HMRC has published a technical consultation on the processes required to implement this change.  That consultation confirms that from 6 April 2027:

• when a pension scheme member dies with unused funds or without having accessed all of their pension entitlements, those unused funds and death benefits will be treated as being part of that person’s estate and may be liable to IHT;
• the change will apply to both DC and DB schemes;
• the current distinction in treatment between discretionary and non-discretionary schemes will be removed (currently only non-discretionary subject to IHT); 
• a small number of specified pension benefits will remain outside the IHT regime, including “where funds can only be used to provide a dependants’ scheme pension”. 

The objective is to harmonise the treatment of DB and DC, discretionary and non-discretionary arrangements.  As the reason for many death benefits being discretionary in the first place relates to protecting them from liability to tax, there is a potentially significant issue tucked away here for the pensions world to get to grips with – if there is no longer a tax advantage for the member / beneficiary in a death benefit being discretionary, should the benefit be reshaped to allow the member to direct where it goes?

The budget document includes an estimate that bringing unused pensions within the scope of IHT will impact around 8% of estates per year – suggesting that no IHT will be payable in most cases (due to the thresholds before which IHT is not payable – allowances vary depending on who is inheriting). 

Nonetheless, making unused DC pots subject to IHT on death will mean an end to their use for tax efficient estate planning and is likely to see sophisticated savers searching for alternatives - which may in turn lead to a reduction in employee contributions (and see below regarding a concern about this in relation to the other Budget changes).  

Delay of implementation until 6 April 2027 gives some time for affected individuals and families to plan, but otherwise there has been no suggestion so far of any transitional protection for those who already have large accrued pots.  

What about non pensions tax changes that impact pensions?

An increase in employer National Insurance Contributions was widely anticipated and the Chancellor duly confirmed the employer’s rate will increase from 13.8% to 15% in April 2025. Further, the threshold at which employers start paying NICs on an individual’s earnings has been reduced from £9,100 per annum to £5,000 per annum. 

This “double whammy” increase won’t have the direct and tangible impact on pensions savings that was feared from the rumoured removal of the NICs exemption for employer pension contributions.  Indeed, for those who pay their pension contributions via salary sacrifice arrangements there is actually an increased benefit, as the saving from doing so increases from 13.8% to 15% (as employer pension contributions remain tax exempt).  So expect increased take up of salary sacrifice arrangements.

However, employers can be expected to manage the NIC increase by potentially suppressing salaries or salary increases or offering fewer contractual hours in order to pay less in NI or passing on the cost increase through higher prices to customers.  Over the longer term, this could mean less going into workers’ pension pots if real term pay decreases, and may lead to fewer workers meeting the minimum earnings thresholds for automatic enrolment. This would be contrary to the Government’s drive to increase retirement adequacy on which Phase 2 of its pensions review will be focussing.

Early commentary from the industry also suggests increased employer costs could stifle development in the fledgling CDC sector.

On the flip side, however, minimum wage increases could lead to higher overall contributions and more people meeting the auto-enrolment threshold, expanding access to workplace pensions arrangements. 

We also note that full-time carers can now earn in excess of £10,000 per year without losing their carers allowance, potentially giving them access to auto-enrolment schemes for the first time. 

Any other pensions news?

There are a few other specific points on pensions in the Budget as follows:

• The Government confirmed its commitment to taking forward the pensions review specifically in relation to driving investment in the UK via pension schemes (this was in the Budget paper rather than specifically mentioned by Rachel Reeves);
• maintenance of the state pension triple lock;
• the Chancellor is following through on a Labour party manifesto commitment to transfer the Mineworkers Pension Scheme’s Investment Reserve Fund to the scheme’s trustees and review the scheme’s surplus sharing arrangements;
• from April 2026, the Government will require scheme administrators of registered pension schemes for Finance Act purposes to be UK resident.  For trust-based schemes the trustee is usually the scheme administrator;
• from April 2025, the conditions of overseas pension schemes (OPS) and recognised overseas pension schemes (ROPS) established in the EEA will be brought in line with OPS and ROPS established in the rest of the world, so that: 
  • OPS established in the EEA will be required to be regulated by a regulator of pension schemes in that country
  • ROPS established in the EEA must be established in a country or territory with which the UK has a double taxation agreement providing for the exchange of information, or a Tax Information Exchange Agreement
• from April 2024, there will be a change to overseas transfers – whereby transfers to schemes in the EEA and Gibraltar will be brought into the QROPS regime and become subject to the 25% Overseas Transfer Charge from 30 October 2024.  This is designed to “address the risk of individuals receiving double tax-free allowances” which arises as a result of the new post LTA abolition lump sum allowances.

In relation to the final three points, a policy paper has been published here, together with draft legislation.  The policy paper explains that the previous rules were put in place to address EU freedom of movement principles at the time.

Comment

This budget was hotly anticipated and rumours swirled for many weeks ahead of the day itself.  Although in the end the changes weren’t as significant or wholesale as many had feared, this is likely to be little consolation to those pension scheme members who acted in anticipation by e.g. drawing down their PCLS early because of the rumours of a reduced cap to come. 

The drawn-out pre-budget process and numerous “leaks” of potential policy changes that didn’t happen may have (further) damaged member trust and confidence in the UK pensions system. The past three months have cast a spotlight – again - on the reality of how easily, and quickly, tax and / or legal changes, whether rumoured or otherwise, can move the goalposts and corner flags of financial decisions already made and made in good faith.

The big news of the day is the introduction of IHT on inherited pension benefits, and its proposed extension across the full pensions landscape (as opposed to DC only).  We are only beginning to get to grips with what is sure to be a complex and developing consultation and it’s a relief to see the Government is giving itself time to think through the technicalities (and the industry and affected individuals time to prepare), with implementation slated for April 2027.

A final point to note is we did wonder if the Chancellor might look more broadly at surpluses in pension arrangements – with many DB schemes now in surplus, relaxing the rules to allow return of surplus to employers more easily might have generated some healthy tax receipts, not to mention a substantial nod in the direct of the Mansion House growth agenda.  But it looks like that is a question for another day. When they do come to consider it, they might want to look no further than the Mineworkers Pension Scheme – this could be considered an interesting case study on how a surplus can be effectively generated by running on a pension scheme that has a strong employer covenant standing behind it.