The government is not short of ideas on how pensions could be changed to meet their needs, whether they meet the needs of consumers however is yet to be seen. Richard Hulbert, Insight Consultant at Defaqto, explains the key six reforms that the Government has proposed in recent months.
It’s clear that Whitehall is looking for ways to cut the costs of pensions for the exchequer. While at the same time, seeking to use existing and future pension savings to boost investment in the wider UK economy, collectively known as UK Productive Finance.
The key areas with proposed changes are:
- Salary sacrifice
- Tax-relief on pension contributions
- Asset allocation
- Closure of some of smaller workplace pensions
- Consolidation of local government pension schemes (LGPS)
- Extending CDC pension remit
Salary sacrifice – capping or stopping?
Salary Sacrifice allows employees to reduce their taxable income in exchange for higher pension contributions. While this encourages saving it leads to lower national insurance (NI) and income tax payments.
HMRC proposedoptions in itspaper published on 27 May entitled, “Understanding the attitudes and behaviours of employers towards salary sacrifice for pensions”.
According to HMRC, removing both income tax and NI from salary sacrifice for an employee on £35,000 could result in:
- An employer paying an extra £242 in NI.
- An employee paying an extra £560 through a combination of NI and Income Tax.
While there is an obvious financial attraction for the government, the impact on millions of individuals and businesses would be significant. Therefore, capping seems the more likely option.
Tax-relief on pension contributions – reform
The cost of tax-relief is estimated at around £70b per year, with over half going to higher rate taxpayers. One way to reduce this burden is to introduce a flat rate for everyone.
The last government commissioned a review into this and on 4 November 2024 UK Parliament published a research briefing entitled. “Reform of pension tax relief”.
Supporters of a flat rate for everyone say it would be fairer for savers to receive the same relief. While opponents argue that higher rate taxpayers would experience ‘double taxation’.
One must also remember that DB pension schemes are reliant upon the full relief to meet their commitments. Any surplus they hold today could vanish through this change.
Two ideas being bounded around are:
- Single flat rate, commonly 25% to 30%.
- Restricting relief available to higher rate taxpayers
Asset allocation – mandated investment into (UK) Productive Finance
The Mansion House Accord signed on 13 May reads:
“The signatories of this Accord express an intent, on a voluntary basis, to achieve a minimum 10% allocation to private markets across all main default funds in their DC schemes by 2030, with at least 5% of the total going to UK private markets.”
However, days later in the proposed 2025 Pension Bill the government introduced a reserve power to enable them to set baseline targets for investment in a broader range of private assets.
This moves asset allocation based on savers needs, to the whims of future governments.
Is this change suitable for consumers?
From an advice perspective, UK Productive Finance includes assets that the FCA classifies as non-standard. They are generally considered high-risk and unsuitable for retail consumers due to their low liquidity, and the difficulties experienced in accurately valuing and trading them.
When attitude to risk is measured on a scale of 1 to 10, with 10 being the greatest level, currently (accumulation) default funds sit around level 7 to 8. The average consumer sits at around level 6. So, we already have a mismatch.
Move 10% into productive finance and go overweight in the UK compared to market capitalisation values and the risk level could increase to 8 or 9. Arguably, making default funds unsuitable for retail consumers.
We therefore anticipate an uplift in pension switching and consolidation recommendations as advisers move pension savings into suitable investments.
Closure of workplace pension schemes
Also within the 2025 Pension Bill is a requirement for DC workplace schemes to have a “megafund” with a minimum of £25bn in assets under management (AUM) from 2030.
Today, 12 providers open to new business have insufficient AUM and risk being closed, they are:
Baptist
BCF
Cheviot
Collegia
Creative
Lewis & Co
NatWest Cushon
now:pensions
Penfold
SEI
Smart Pension
True Potential
If you are looking for innovation, fantastic service, top performance, low cost and overall value for money then ironically you will find it within the very schemes at risk of being closed.
Consolidation of local government pension schemes (LGPS)
Government is seeking the 86 LGPSs to consolidate into six to eightpools to unlock lower costs and create mega funds investing in UK Productive Finance. Details are in the paper, “LGPS: Fit for the future – government response” published on 29 May 2025.
Advice firms will be concerned by this. Firms that provide services to LGPS also provide products and services that advice firms rely on. After losing LGPS contracts we may see them reduce their research, increase their costs, merge funds, and/or close them.
Extending CDC pension remit
In May the Pensions Minister, Torsten Bell, confirmed plans to extend collective defined contribution (CDC) to multi-employer schemes in the autumn. This will unlock collective decumulation, a benefit many Master Trusts are keen to employ.
In June the Reform Party identified LGPSs as being unsustainable. We therefore wonder if CDC will replace LGPS, in the same way Royal Mail replaced its DB scheme.
Increase in State Pension Age
Around the world governments have increased their ages as they seek to cut costs. Denmark being the latest, moving to age to 70 for those born in 1971 onwards. The oldest in Europe.
With billions of pounds to be saved by copying Denmark, it would be naive to think that someone in Whitehall is not considering a similar increase here.
Conclusion
Most of the proposals appear to cost savers money and increase their risks. Add to this state control of asset allocation, and reduced competition, and it’s clear these changes are not without potential issues.
That said, if pension savings can be redirected to help grow the UK economy while making savers better off, then its likely reforms will be progressed but it needs to be done with some safeguards in place.
About Richard Hulbert
Richard Hulbert is an Insight Consultant at Defatqo covering investments and their distribution, notably through bonds, platforms, and pensions.
