Budget 2025: how pensions and ISAs could change

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We’re now less than a month away from Chancellor Rachel Reeves delivering this year’s Budget. As ever, there have been plenty of rumours regrading the contents of the famous red briefcase, with reform mooted for both pensions and ISAs.

To discuss what to potentially expect, Kyle is joined by Craig Rickman, personal finance editor at interactive investor. The duo also debate the fiscal black hole, whether Labour will break its manifesto promise not to increase taxes on working people, and potential further changes to inheritance tax (IHT) and capital gains tax (CGT).  

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to On The Money, a weekly show that aims to help you make the most out of your savings and investments.

In this episode, we’re going to be covering what to expect from the Budget in late November. As usual, there’s plenty of rumours and speculation about how the nation’s personal finances may be impacted when Chancellor Rachel Reeves unveils the contents of the famous red briefcase on 26 November.

Now, just a caveat, we’re recording this podcast on Friday 24 October, which is just over a month before the Budget. So, please do bear that in mind, particularly if you’re listening to the podcast or watching it on YouTube in a couple of weeks’ time.

However, given that there’s already been plenty of pension, ISA and other rumours, we wanted to do our Budget preview show now rather than wait until near the time.

Joining me to discuss what to expect from the Budget and to offer his expert insights is Craig Rickman, personal finance editor at interactive investor. Craig, great to have you back on the podcast.

Craig Rickman: Thank you very much for having me back on.

Kyle Caldwell: So, Craig, let’s start off by setting the scene. So, a fiscal black hole has emerged. Some estimate this black hole as being around £30 billion, while some estimate it to be up towards £50 billion. Why is there this black hole? What’s caused it?

Craig Rickman: To try and be as brief as possible with this, when the government came to power and Rachel Reeves assumed the position of chancellor, she set herself these narrow, iron-clad fiscal rules. The main one of which is that day-to-day spending would be funded by tax receipts. So, the government would only borrow to invest.

But due to a cocktail of factors this year, such as soaring borrowing costs, which have eased a bit recently but are still really high, some policy U-turns such as winter fuel and the UK’s tepid economic growth, it has created this gap between what the government is getting in tax and what it’s spending, and hence, this black hole.

That explains why we’ve had the return of all these rumours around what might happen, particularly in terms of tax hikes because if the government wants to plug that black hole, then they’re either going to have to raise taxes, cut spending, or more likely a combination of the two.

Kyle Caldwell: In terms of addressing this fiscal black hole, the government has backed itself into a bit of a corner. It made a manifesto pledge not to increase taxes on working people. It pledged not to raise income tax, national insurance, or VAT during its five-year parliamentary term, and it also committed to not raising corporation tax too.

Some think that Reeves may now be forced to row back on this pledge, and there have been some rumours, Craig, that in respect of income tax we may well see a rise in the Budget.

Craig Rickman: Yes. Well, it seems desperate times may have to be met with desperate measures. So, yeah, it’s been reported that the government is eyeing up raising the basic rate of income tax by a penny. It’s currently 20%, so there’s talk that it could be raised to 21%, which could potentially raise £8 billion. So, a significant sum.

But this would be a controversial move for a few reasons. The first one is, as you noted, that with the manifesto pledge, it would involve breaking that. And further to that, Labour has repeatedly said it’s those with the broadest shoulders that would face the highest burden. And this would affect a lot of people with the basic rate of tax.

Some believe that the government may instead target the higher rates of tax, so the 40% rate and the 45% rate. The problem there is that it wouldn’t raise as much revenue, so the juice may not be worth the squeeze there. So, that’s another thing.

What we must also take into account is that raising the basic rate of income tax wouldn’t just affect earnings. There’s lots of other things that it would impact as well.

So, any pension income, whether that’s from drawdown and annuities, particularly as we expect from April, the full state pension is likely to almost fully absorb the tax-free allowance due to the triple lock, provided that’s pushed through at the Budget.

So, it means that any other income that people receive in retirement will be taxed. It also affects rental income, the interest that we pay as well.

I guess the other point as well is that raising the basic rate of income tax at a time when the cost-of-living crisis is still enduring. I mean, inflation has plateaued. It’s been 3.8% for the past few months, but that’s still far higher than the Bank of England would like it to be. So, it would a deeply controversial thing to happen, but perhaps the government feels they’ve got no choice.

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Kyle Caldwell: Well, let’s now move on, Craig, to the rumours around pensions. Of course, it wouldn’t be the run-up to a Budget without some speculation on potential changes to the pension tax regime.

Although, hopefully, they won’t come to fruition, particularly after the inheritance tax proposals that were announced last year, which come into effect in April 2027.

So, Craig, the main rumour at the moment is that there may be changes to tax-free cash. So, under the pension rules, if you’re taking your pension flexibly under pension freedoms, you can withdraw 25% of your pot tax free up to a maximum limit.

Could you talk us through, Craig, what the maximum limit is and what the fears are regarding how that may be reduced?

Craig Rickman: Sure. Yeah. So, speculation about tax-free cash, in a sort of déjà vu repeat of last year’s Budget, have really dominated the headlines. We’ll come on to that in a second.

So, the rules around making tax-free pension withdrawals. Those with defined contribution pensions, most people with defined contribution pensions can take up to 25% of their pot tax free, and this is capped at £268,275. You don’t have to take all your tax-free cash in one go. When you hit the age of 55 – it’s currently 55, but it’s going up to 57 in a few years’ time - you don’t have to take the lot in one hit. You can take it in stages.

But around the maximum amount of tax-free cash is where a lot of the fears are, and that’s where the speculated changes are homing in on. The £268,275 figure could be reduced to a £100,000. Like you said earlier, I hope that the pension tax system is left alone. People need consistency there. But there are a lot of fears that it might be cut.

Financial advisers have been seeing increased inquiries from clients about whether they should draw their tax-free cash now to try to get ahead of any potential changes. There’s some Financial Conduct Authority (FCA) data as well that showed that tax-free withdrawals had upticked in the past year.

I think we should note that that’s not the only reason, or that people aren’t accessing more tax-free cash than they were before just because of the Budget rumours. There are other reasons too. As you noted, the forthcoming change to IHT.

So, with pensions set to be brought into the inheritance tax net from April 2027, some people are accessing their pensions to avoid their heirs potentially paying double taxation on death if they were to pass away after age 75.

Because at that point, whoever receives it could pay both inheritance tax and income tax. That’s another reason.

Kyle Caldwell: As well as concerns that tax-free cash may be meddled with, there are also some rumours doing the rounds, Craig, that there may be changes to pension tax relief.

I remember around a decade ago, back when George Osborne was chancellor, there were lots of reports and concerns that higher-rate pension tax relief would be meddled with. But reforming upfront pension tax relief is complicated.

Craig, what are your thoughts on this rumour and this potential change? There have been some reports that the government may introduce a flat rate of pension tax relief. Could you talk us through this?

Craig Rickman:Sure, yeah. So, rumours about moving to a flat rate of pension tax relief or upfront pension tax relief have emerged before pretty much every major fiscal event in the past 10 years. It’s never happened, partly because, as you’ve said, it’s not a simple thing to implement. It’s not a simple thing to change.

But there are a couple of rumours around this and a couple of ways the government could do it. The reason why it may be looked at is because it costs the government a lot of money every year. So, more than £50 billion [is what] the government shells out on pension tax relief, and around two-thirds of that figure is claimed by the higher earners. So, those who pay 40% or 45% tax.

So, if the government does need to raise money by restricting pension tax relief for higher earners, it’s seen as a way to raise some cash and potentially plug that fiscal black hole.

There are a couple of ways that they could do it. The most extreme is just to completely remove higher-rate tax relief on pension contributions. Everyone would get 20%. That would be aggressive. That would really disincentivise anyone who pays higher rates of tax from paying into a pension. They may actually turn to other assets. So, that’s the most extreme option.

The alternative is, like you say, to introduce a flat rate. So, let’s say that’s 30%, so that lower earners get a bit of a boost, but higher earners don’t get as much relief. If that were to happen, if your income’s more than £50,270, which is the higher-rate tax threshold, you would lose out. But if your income’s below it, you would gain from it.

But it’s very complicated, more so [by] the fact that a lot of pension tax relief is claimed by defined benefit schemes. Some people have speculated that if a flat rate was introduced, then it could spark the demise of many of the last standing of the defined benefit schemes in the private sector. So, yeah, it’s a complicated one.

These rumours surface every time. They’re back here again. But, again, we’ll have to wait and see what happens on 26 November.

Kyle Caldwell: And due to fiscal drag, so the freezing of the income tax thresholds, which has been the case now for several years, and we may well get an announcement in the Budget about whether that policy will continue, the fact is that more and more people are now higher-rate taxpayers and will be impacted by any potential changes to pension tax relief.

Craig Rickman: Absolutely, yeah. Moving to a flat rate of pension tax relief wouldn’t just affect higher earners or the highest earners. Like you say, more and more people, millions more people, are tripping into the higher-rate tax band, becoming higher-rate taxpayers due to, like you say, tax thresholds being frozen and rising income. So, yeah, this would affect a lot of people.

A lot of what would be seen as sort of ‘Middle England’ would be affected by a flat rate of pension tax relief, and it would harm their ability to save for retirement because the tax relief that you get up front with a pension is one of the really attractive parts of it, perhaps the most attractive.

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Kyle Caldwell: A final point on pensions is that I’ve not really seen any rumours or speculation that there’ll be any changes to the pension triple lock. There have, in the past, been rumors that the pension triple lock may be reformed into a potential double lock, removing the earnings elements of the equation, but I’ve not seen any speculation so far. Have you, Craig?

Craig Rickman: No. Well, the government is committed to the triple lock for the rest of this parliament. So, we wouldn’t expect any changes. I guess it’s more the long-term future of the state pension and particularly the state pension triple lock, which is less clear.

Kyle Caldwell: Let’s now move on to potential reform to ISAs. You mentioned earlier, Craig, a sense of déjà vu, and this is also the case for ISAs. It’s been rumored for a while now that there may be changes to cash ISAs, that the annual £20,000 limit for the cash ISA version may be cut. I’ve seen reports that it may be cut to £10,000. Could you talk us through this?

Craig Rickman: Sure, yeah. Like you say, there’ve been lots of rumours around potential cuts to the cash ISA allowance throughout the year, really.

It was actually expected to be announced by Rachel Reeves [in her] Mansion House speech. On that occasion, the cut was going to be a lot, it was speculated to be a lot heavier. It could have been as low as £4,000.

The aim for the government, which I think is a laudable one, is to try and encourage more people to invest. The problem is reducing the cash ISA allowance, the silver bullet to achieving that. Probably not.

But the reports this time around in the lead up to the Budget are suggesting that [Reeves] may cut the cash ISA allowance to £10,000. So, the overall ISA allowance of £20,000 remains, but you could only stick £10,000 into a cash ISA every year.

Kyle Caldwell: Ahead of that Mansion House speech, which was back in July, the rumour was that the cash ISA allowance would be cut to £5,000, whereas now the reports are that it could be cut to £10,000.

My view is that it’s not a potential silver bullet. I think if you’ve only got your money in cash savings and the allowance is cut, it’s not necessarily going to incentivise you to then put money into the stocks and shares ISA version.

I think the most important thing is that education is key and the government’s increasing efforts around investment education to get across to people the importance of investing for your financial future, to get across that it’s actually not that difficult.

And, yes, of course, with investing, it does carry greater levels of risk versus putting your money in a bank or in a savings account elsewhere.

But the fact is that over the long term, the history books do indeed show that the best way to potentially grow your wealth over the long term is to invest it.

Whereas if you keep it in cash, what happens here is that your money gets eroded by inflation. So, if you want to try and grow your money in real terms and beat inflation, the best way is to invest it.

I just think that more needs to be done to get this message out to the wider public, to get across the merits of investing and the importance of it.

And to talk about and educate people on things like the power of investing for the long term and the power of compound returns and how they can benefit you over the long term.

Craig Rickman: Yeah, and this is clearly something that the government is looking at. There were some other announcements in the Mansion House speech around this, so around changing the narrative around risk warnings when it comes to investing. There’s going to be an advertising campaign. We’ve got the targeted support regime, which will be available from April year.

So, there’s lots of other things going on, but that’s where the debate is around the cash ISA limit - will it make a difference? In fact, I polled some interactive investor Community members from our Community app over the summer about what they think should happen to the cash ISA limit, and two-thirds said that they think it should stay at £20,000. So, these are experienced investors. So, the vast majority think it should stay, but it’s a hugely divisive topic.

There are other things that the government could look at in terms of ISAs at the Budget, but that’s been the big rumour.

Kyle Caldwell: Even if the cash ISA allowance is cut, you can still squirrel a lot away and not pay tax. So, under the personal savings allowance, if you’re a basic-rate taxpayer, the threshold is £1,000 before you start paying tax on savings interest. So, if you’re in a savings account and it’s paying 4% a year, then you’d need over £25,000 to breach that limit.

Craig Rickman: Absolutely, yeah. That’s worth bearing in mind. What’s also worth bearing in mind if you’re a higher-rate taxpayer, is your savings allowance is only £500.

As we’ve been discussing, more and more people are tripping into the higher rate of tax. For an additional-rate taxpayer, if you earn more than a £125,140, you don’t get a savings allowance. It’s important things for people to know and appreciate, especially if there are cuts to the cash ISA limit.

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Kyle Caldwell:Let’s now move on to the stocks and shares ISA. So, I’ve seen rumours that the chancellor is considering sectioning off a portion of the stocks and shares ISA just to invest in the UK stock market.

So, I’m just going to spell out both sides of the debate. On the one hand, I can see why the government is keen to try and increase money going into the UK stock market and UK companies as, of course, this will benefit the UK economy. The fact is, since the Brexit vote, every single month, pretty much, we’ve seen more money exit UK funds rather than enter UK funds.

So, there’s been billions of pounds flooding out of UK funds since then, and a lot of that money has gone into global funds that invest in overseas shares. Global funds also typically have some exposure to the UK as well.

There’s also the argument given that we get tax breaks in ISAs, so the investment returns are tax free, that this should make us all a bit more patriotic and wanting to put money into the UK stock market.

However, for me personally, I wouldn’t want to be restricted. I’d want to invest where I see fit. I’d want to invest globally. I’d want to achieve global diversification with my own investments, and I think a lot of other people will have the same view.

Also, I just think it might be really hard to administer. Say, if £5,000 of the £20,000 has to be invested in the UK, how is that going to be policed, and who’s going to police it?

The government was seriously looking into a potential British ISA not too long ago, and that was the idea of the previous Conservative government in which there’d be a separate ISA just to invest in the UK market, the so-called British ISA. The idea here was that it would be £5,000.

The concerns with this ISA, though, was that people would only use it if they’d already maximised the £20,000 stocks and shares ISA allowance. So, the concerns were, would there be a lot of demand for that ISA.

However, whatever your views are on that, I do think that’s a cleaner way to do it rather than section off a part of the existing stock and shares ISA.

As we’ve spoken about before in a previous episode when we examined the potential British ISA, at the end of the day, if you’re investing in the FTSE 100, if you’re investing in an index fund or an exchange-traded fund (ETF) that’s tracking the fortunes of the 100 largest companies that are listed in the UK, the majority of them are global businesses. They make most of their money overseas. So, there are no guarantees that it would benefit domestic UK businesses that make most of their money here rather than overseas.

Craig Rickman: Absolutely, yeah. And it could also make things a bit more complicated or add more knots to the ISA landscape at a time when we really need to make things simpler and easier for people to understand as well.

Kyle Caldwell: In terms of the existing ISA regime, there are a handful of different ISAs, which complicates matters, and there have been rumours of potential changes to the Lifetime ISA. So, this is the ISA whereby you either invest for your first property purchase or it’s used for your retirement. Craig, what are the potential changes on the cards?

Craig Rickman: Back in January, the Treasury Select Committee started looking at the Lifetime ISA. For quite a long time, people have flagged some problems with the product, some concerns. It’s a dual-purpose ISA. So, you can either use the money to buy a first home or you can use it to fund your retirement.

The big benefit to the Lifetime ISA is that you get a bonus on what you pay in, and that bonus is 25%. The maximum you can pay into a Lifetime ISA every year is £4,000. So, if you put £4,000 in, you get an extra £1,000.

But there are some concerns about how the product works, whether it’s truly fit for purpose. I’ll flag the two main problems with it. The first is that if you’re looking to use a Lifetime ISA to buy your first home, the maximum property value that you can buy is £450,000.

That figure has been fixed since the Lifetime ISA was launched in 2017. So, for some people, especially those perhaps in London or in the South East, the home that they want to buy might be more expensive than that.

So, they can still take the money out of the LISA, but this leads us to the second problem with it, which is that if you access the money from your LISA, which isn’t used for either of those purposes, so buying a first home or retirement, then you pay a penalty. The penalty is 25% on whatever you withdraw. So, that’s on what you’ve paid in, plus any growth.

So, it’s highly likely that the penalty will outstrip - and potentially by a reasonable margin - the bonus that you received. So, yeah, there are problems there.

I think there has been quite a lot of data showing that there’s been an increasing number of people who are paying the penalties on LISAs.

So, it’s a slightly confused product. The Treasury Select Committee are looking at it, whether to scrap it entirely or reform it, which I think is probably the most likely, or whether to keep it the way it is. Perhaps we’ll get an answer to that on 26 November.

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Kyle Caldwell:So, Craig, we’ve covered off the rumours regarding pensions and ISAs. Now, there are lots of other personal finance-related rumours of potential changes in the upcoming Budget.

However, I think we would need probably another hour or two to cover them on this podcast. So, let’s end this episode by focusing on wealth taxes.

While there’s never actually been a wealth tax in the UK, there have been rumours that such a policy could be on the cards.

Unlike capital gains tax, which is paid when an asset is sold at a profit, the idea of a wealth tax is a one-off windfall measure, or an ongoing tax based on the value of the assets held even if they’re not sold.

The good news is that Chancellor Rachel Reeves has ruled out a potential wealth tax. However, there have been reports that the government could make further changes to the existing inheritance tax and capital gains tax regimes.

Craig, could you talk us through the speculation regarding both of those?

Craig Rickman: Sure, yeah. So, those two taxes were targeted last year. Capital gains tax rates were increased if you were selling shares and other assets, or they were brought in line with residential properties.

Before that, there used to be different rates of capital gains tax depending on whether you were selling shares or other assets or a second home. So, they were brought in line, which was a tax increase for some investors.

Then we had sweeping changes to the inheritance tax regime affecting farms, businesses, pensions, AIM shares.

Apparently, further reforms to these two sort-of wealth taxes, or what sit under the capital taxes banner, are being considered by the government. One of the rumours around CGT is a repeat of last year, which is to bring capital gains tax rates in line with income tax, which would be an incredibly heavy hike. So that’s being rumoured.

In terms of inheritance tax, the rumours are focused on the gifting rules. At the moment, if you gift certain assets, then provided you survive seven years, that money moves outside your estate, and becomes inheritance tax-free. There are rumours that that could be extended to 10 years in what would be a deeply unpopular move.

Any changes around inheritance tax will always be unpopular, as we saw last year. It’s not that any taxes are liked, but people have a particular dislike for inheritance tax.

So, anything that increases the rates, makes it harder to give money, tightens the rules, is not going to be very popular as we saw with regards to the backlash of the reports that we had last year.

Further reforms in those areas are possible, but my view is, particularly around inheritance tax and the response to the reforms at the previous Budget, that the government might tread a bit carefully in that area.

Kyle Caldwell: So, inheritance tax and capital gains tax, they were the last two items on our list of things to cover in our preview episode of what may be in store in the Budget.

However, before I conclude, Craig, I think it’s important to stress the importance of not making any knee-jerk reactions. At the end of the day, there’s a lot of speculation and rumours, but nothing is currently set in stone, and we won’t know the items in Rachel Reeves’ briefcase until 26 November when the Budget is delivered.

Craig Rickman: Absolutely. I think that message is particularly important around things like pension tax-free cash. If you’re thinking about doing something about that before the Budget, as HMRC and the Financial Conduct Authority recently confirmed or reiterated, once you’ve made a tax-free withdrawal from your pension, you can’t change your mind later. It’s a one and done decision.

That doesn’t necessarily mean that you shouldn’t make a tax-free cash withdrawal before the Budget. There are good reasons to do so. Like I said earlier, you don’t have to take the lot in one hit. But for some people, that’s the right thing to do if they’ve got a purpose for the money.

But the thing to be wary of is if you’re making a decision purely based on the speculation because it’s a decision, especially if nothing happens with tax-free cash at the Budget, that you might live to regret.

Kyle Caldwell: We will, of course, be covering the Budget on ii.co.uk, and we’ll also be doing a podcast episode analysing what’s been announced and how it will be impacting the nation’s personal finances. But until then, Craig, thank you for your time today.

Craig Rickman: Thanks a lot as always, Kyle.

Kyle Caldwell: Thank you for listening to this episode of On The Money. If you enjoyed it, please let us know what you think. You can comment on your preferred podcast app, and if you could leave us a rating or a review, that would be much appreciated as those ratings and reviews are really important to help spread the word about the podcast.

In the meantime, you can find more practical pointers and analysis on the interactive investor website, which is ii.co.uk.

Hopefully, I’ll see you again next time.