Millions more people could be impacted by Rachel Reeves’ changes to workplace pensions than originally thought, the Office for Budget Responsibility (OBR) has warned.
In November’s Budget, the chancellor announced that, from 2029, workers will face a £2,000 cap on the amount they can save into a pension through salary sacrifice schemes, after which further contributions are subject to National Insurance (NI).
Currently, any contributions made through the scheme before salaries are paid to workers are exempt from NI and tax, making it an attractive and tax-efficient way to save for retirement, as well as to lower potential tax obligations elsewhere.
Somebody on a £40,000 salary contributing five per cent towards their pension – often the default starting point once auto-enrolment kicks in – would hit that £2,000 limit annually, meaning any further salary raises, pension contributions or job switches to a higher-paying position would result in higher NI payments.
Initially, it was estimated that fewer than half (44 per cent) of workers using salary sacrifice would be affected, equivalent to around 3.4m individuals.
But further analysis by the OBR now suggests another 4.3m people, who do not typically earn enough to breach that £2,000 annual allowance, could also be impacted by Reeves’ changes – depending on how businesses react to the cap.
The OBR has cautioned that it remains “highly uncertain” how firms will respond to the new limits, suggesting that options include lowering an employee’s contractual salary in exchange for higher pension contributions from the employer.
While employee contributions face the cap-and-tax situation, that does not apply to company contributions, which can be raised without additional cost beyond the pension amount itself. However, the OBR also notes that rules dictate that companies would have to apply this “across the workforce”, which may limit some firms’ ability to do so.
Relief at source (RAS) schemes are another option, which would see workers need to file self-assessment tax returns to claim back their extra pension tax relief if they are higher or additional rate earners.
Get a free fractional share worth up to £100.
Capital at risk.
Terms and conditions apply.
ADVERTISEMENT
Get a free fractional share worth up to £100.
Capital at risk.
Terms and conditions apply.
ADVERTISEMENT
“When an employee contributes to a RAS scheme, they will initially pay higherand additional-rate income tax on their pension contributions and then reclaim this the next year,” said the OBR, noting it could lead to a permanent bump in Treasury take of around £0.2bn annually from 2030 onwards, in part due to unclaimed relief – essentially when people do not claim back the money they are entitled to.
In addition to forecast changes by employers in how they manage pension payments, the OBR say their calculations “includes the assumption that employers will seek to pass 50 per cent of this additional cost to employees through lower ordinary employer contributions, which are not taxed, and 50 per cent through to lower salaries and bonuses, which are taxed”.
Tom Selby, director of public policy at AJ Bell, said that it added up to another tax on firms that faced high added costs last year. “A significant unknown danger in capping salary sacrifice was always, and remains, the reaction of employers offering these arrangements. Some may simply decide that offering salary sacrifice is no longer worth it, while others could simply pare back pension contributions or other forms of remuneration to make the numbers add up,” he said.
“Ultimately, this is another tax on business, and firms have three options: absorb that extra cost, cut back on plans to invest or hit employees in the pocket.”
With regards to what workers should be doing now, Mr Selby added that there were other ways to manage salary limits and also to focus on the future by making contributions now if they are able.
“Employees currently in salary sacrifice arrangements who will be affected by the decision may want to have a conversation with their employer to ensure they are making the most of the benefit while they still can,” he said.
“It’s important to remember that, in relation to things like free childcare, salary sacrifice isn’t the only way to reduce your salary below that key £100,000 threshold – personal pension contributions are also subtracted from your adjusted net income measure when determining whether you qualify or not.
“But fundamentally, there is no need for anyone to panic about this – you will still get income tax relief on your pension contributions from 2029 and firms will still be required to ‘match’ contributions in your workplace pension scheme.”