What should pension funds, their sponsoring employers and their advisors look out for in the 2026 Budget?

Just under a month ahead of the new Chancellor John Healey’s first Budget, it’s safe to say the focus is firmly on the state pension. The Prime Minister has announced today (Tuesday 29 September) that the triple lock will be maintained for the remainder of this Parliament but then adjusted from 2030, so that the state pension will then rise in line with prices with a 2.5% underpin. The Prime Minister said that the state pension will “hold its value relative to earnings" - further details about the meaning of that are awaited. 

However, while the triple lock may be attracting all the headlines, there are plenty of other areas where we might see changes to pensions benefits and taxation in the Budget. Here are seven key areas to keep an eye on: 

1. Tax free cash

Whether there might be changes to the amount of tax free cash members can withdraw at retirement is a question that crops up ahead of every Budget. In recent years the speculation has been particularly fevered. In the past this has led some members to make hasty decisions in order to draw down lump sums in anticipation of rumoured changes that didn’t come to pass. FCA figures highlighted by the Financial Times recently indicate that the amount of money withdrawn in the form of a PCLS has nearly doubled since July 2024 – attributed in that article to a combination of concerns about possible changes to the PCLS and a response to the forthcoming changes to inheritance tax on pensions.

It is therefore worth reminding members considering withdrawals in this pre budget period that, other in very limited circumstances, once a withdrawal has been made it cannot be unwound. For more on HMRC’s guidance in this area please see our article.

Without wishing to add fuel to the speculation fire, it would be remiss not to highlight that this remains an area to keep under review this Budget. FCA figures quoted by the Financial Times piece indicate in the 2025/26 tax year £22bn was withdrawn as a PCLS. Given that context, it’s clear that even a small reduction in the proportion of pension that could be drawn tax free could yield a significant return. In the context of increasing concerns about a pensions adequacy “time bomb”, arguably there are also sound policy reasons why the Government might wish to encourage pension pots to be paid out as pensions and not cash lump sums (and the Pensions Minister made comments along a similar theme when he was Chair of the Resolution Foundation).

That said, the tax free cash lump sum is perhaps the most valued and best understood aspect of pension benefits. This makes it politically sensitive to change. Nevertheless, could a new Prime Minister consider reforms to the PCLS parameters? 

2. Tax on pension contributions

From a benefit that is well understood and highly valued by members, to one that many have only a very limited understanding of. 

As part of the EET (exempt-> exempt -> taxed) structure of our pensions system, member contributions to their pensions benefit from tax relief at the member’s marginal income rate. This means that higher rate taxpayers benefit the most from the current system. Whilst a wholescale structural change to the current EET model seems unlikely, might we see, for example, a move to a flat rate of tax relief? This is a change that has been mooted ahead of recent budgets, partly driven by an understanding that this was a position Rachel Reeves had favoured in the past (though not one she put forward as Chancellor).

Those in favour of a flat rate argue that the current model disproportionately favours higher earners and does not provide sufficient incentive for low and medium earners to save. This 2024 commentary from the Institute for Fiscal Studies concludes that reducing up front relief for higher rate taxpayers could generate some £15bn in additional tax revenue. However, it also highlights that there is “no coherent logic to making relief on contributions flat rate while continuing to tax pension income at the individual’s marginal rate”. Indeed, a move to e.g. a 20% flat rate (as has been modelled by organisations such as the Resolution Foundation in previous years) would represent a windfall for basic rate taxpayers.

3. Salary sacrifice

Significant changes to salary sacrifice arrangements were announced in the 2025 Budget. However, the new £2,000 cap on the amount of pension contributions that will benefit from NICs relief is not due to come into force until April 2029. Although the legislation is already on the statute books, is there scope for further change here? Employers still working out how they will adapt to the forthcoming 2029 changes will hope not but it is possible that the new Chancellor may look again at the shape and quantum of the cap. 

It is worth noting that, like so many of the other changes the Chancellor could look to make to pensions tax, there is a tension here with the Government’s concerns about pensions adequacy. Reducing the generosity of existing incentives for members to save into their pensions risks compounding these issues.

4. Frozen allowances

Fiscal creep – the result of frozen thresholds leading to increased tax receipts as a result of inflation / wage growth – has been a feature of budgets of recent years. While the focus for many has been on the frozen income tax bands (which of course impacts pensions in payment), there are other frozen thresholds for pension savers to consider.

For example, the lump sum allowance (introduced in April 2024 following the abolition of the lifetime allowance) was fixed at 25% of the LTA at the date of abolition - £268,275. No increase to the cap was made last year and there is no provision in the legislation for it to increase in future. With few members currently affected by the cap we’re not expecting an increase to be announced in this year’s Budget either but it’s worth keeping on radar – successive years of freezing will mean the value of the allowance is eroded over time and bring more members within its parameters, particularly in the public sector where the majority of schemes are both defined benefit and open to accrual. Indeed, the fact that there is already effectively a specific monetary cap on the tax free cash taken at retirement is itself worth noting – it could be tempting to seek to reduce the level of the cap further whilst preserving the 25% limit for majority of savers.

Similar considerations will apply in relation to the salary sacrifice cap when it comes in in 2029 – again there is no requirement in the legislation for the cap to increase, meaning the real value will be eroded over time without Government intervention.

5. Return of surplus to employers 

This is an interesting area. With the Pension Schemes Act 2026 (PSA26) reforms to make surplus release accessible to more schemes due to come into force in April 2027, is there any scope for the Chancellor to look again at tax on “refunds” of surplus paid to employers? In view of the context for the change, being the Government’s desire to encourage schemes to run on and generate both returns and economic growth, there just might be.

Of course, the applicable rate of tax has already been reduced from 35% to 25% from 6 April 2024. In its May 2025 response to the 2024 “Options for DB schemes” consultation, the DWP said that it considered the “pensions tax framework is broadly balanced and fair” and highlighted the April 2024 reduction. However, it went on to say that it was “continuing to consider the tax regime for surplus extraction”. Might we see a further reduction in the rate in 2026, aimed at stimulating the DB run on market by providing a fiscal incentive as the PSA26 removes some of the legal barriers? Or perhaps a provision could be made for a reduced tax rate to be payable where the released funds are used by the employer for a purpose the Government is keen to incentivise, be that increased employer contributions for the current workforce (likely to be in a DC arrangement), investment in its UK business or perhaps some ESG aligned goal (solar panels for example)?

There is also an outstanding technical question relating to how the existing 25% tax on employer surplus payments is calculated – HMRC has shared its interpretation in its October 2024 newsletter, which leads to a more generous tax yield for the Treasury. However, many legal professionals consider the alternative interpretation, which leads to a smaller tax bill for the employer, to be the correct reading of the legislation. It’s a technical point but has material value; is there an outside chance the meaning might be clarified given the wider policy perspective ahead of the April 2027 changes coming into force?

6. Increases on pre 1997 pensions

The 2025 Budget included the announcement that led to provisions being added to the PSA26 requiring increases to be paid on pre 1997 pensions for members of the PPF and FAS whose predecessor schemes provided for this benefit. 

This change was widely welcomed in the industry but might the Government decide to go further? In the context of escalating cost of living pressures, campaign groups have been increasingly vocal in recent years about the plight of those living on pensions with a large proportion of non-escalating pre 1997 benefits, the value of which has been eroded by inflation. 

A blanket requirement for all pre 1997 benefits to receive increases would be very difficult to implement given the additional cost burden. Given the improved funding position of DB schemes could we see, for example, a requirement that where a scheme has a significant funding surplus a proportion must be used to fund uplifts for pre 1997 benefits? This would hark back to provisions enacted by the Social Security Act 1990 but never brought into force before their repeal in 1994. These would have required schemes in surplus having to provide for increases to accrued pensions out of the surplus. 

7. Inheritance tax 

With the changes to IHT on unused pension pots and death benefits due to take effect in April 2027 we are a very long way down the road towards implementation. Could the Government be considering a U-turn given the change in leadership? Leaving aside the tax consequences for affected individuals, given the anticipated administrative and practical challenges, pension scheme administrators and personal representatives may well be hoping so.

With just under a month still to go before Budget Day it’s possible that the direction of travel may become clearer in the coming weeks. We’ll be keeping a close eye on developments in preparation for 28 October – look out for our predictions across key practice areas and sectors (including pensions) to come as the day approaches.

This article was written by Louise Pettit, with thanks to Richard Knight, Alice Honeywill and Rachael Skuse for your thoughtful comments