State pensioners face losing 25% of their pension savings following a tax rule change in Labour’s October Budget.

Chancellor Rachel Reeves closed a tax loophole that allowed people to leave £1,073,100 in their UK pension and transfer the remainder into a qualifying overseas scheme.

It meant that retirees could take a quarter of their pension pot (£268,275) tax-free from their UK scheme as well as a tax-free cash entitlement from their overseas scheme.

But a rule change announced in the October Budget now means that people transferring money abroad will be hit with a 25% overseas transfer change (OTC).

The OTC was first introduced in 2017 on transfers from UK registered pension schemes to qualifying overseas pension schemes (QROPS) within the European Economic Area or Gibraltar in a move to prevent tax avoidance through pension transfers abroad.

This charge was then changed after the scrapping of the lifetime allowance, creating an exemption for transfers up to £1,073,100. But the October Budget eliminated this exemption with immediate effect, with Labour claiming the loophole closure will raise up to £5 million a year.

Under the new rules, pensioners will need to be a resident in the same country as their QROPS to avoid the 25% charge. As such, it will be costly for those who want to reside in one country and transfer their pension to another.

The change aimed to address what HMRC identified as a significant loophole that allowed people to claim double tax-free allowances.

A policy paper by HMRC found the loophole as a potential reason for around £1 billion of UK tax-relieved pension savings being transferred overseas.

Commenting on the closure of the loophole, Rachel Vahey, head of public policy at AJ Bell, warned: “One consequence is those who want to retire overseas, but where there are no QROPS registered in their new country of residence, will be forced to keep their pension scheme in the UK or face a 25 per cent charge on transfer.

“As overseas residents may struggle to hold a UK bank account, and many UK pension schemes won’t pay to non-UK bank accounts, this could leave these overseas retirees in a difficult position. Even where they can hold an account, they still face a harsh choice whether to juggle currency risks when taking pension income or lose 25% of their pension wealth on transfer.”