Pension savers were dealt a blow in the Budget as contributions under popular salary sacrifice schemes were capped at £2,000 each year.
The raid will be delayed until April 2029, but will raise £4.7billion that year and £2.6billion in the following year.
Salary sacrifice schemes allow workers to take a supposed ‘pay cut’, with the money paid into their pension or put towards some other benefit like childcare instead.
Both they and their employer pay less National Insurance as a result, which has made operating workplace pensions as salary sacrifice schemes increasingly popular.
But Chancellor Rachel Reeves has now capped how much staff can pay into pensions using salary sacrifice, which will mean workers with defined contribution pensions – the vast majority in the private sector – lose a valuable retirement saving break.
There are also fears that an extra National Insurance cost to employers may lead to them cutting back on schemes that offer more generous pension contributions than the bare minimum required by law.
We explain what you need to know about pension salary sacrifice and the Budget cut.
Rachel Reeves has introduced a cap on salary sacrifice pension savings of just £2,000 a year
The Budget salary sacrifice cap
Rachel Reeves has capped the amount workers can salary sacrifice into pensions without having to pay National Insurance at £2,000 a year. Above this standard rates of NI will be charged at 8 per cent on basic rate earnings, up to £50,270, and 2 per cent above this in the higher rate thresholds
Workers who exceed the cap will therefore have to stump up more to end up with the same amount in their pensions.
Employers might see knock-on effects from changes in behaviour by their staff, as if less money is salary sacrificed into pensions it will instead be paid in wages, which incur full NI.
Also, if an employee gives up part of their salary to boost their pension, only the first £2,000 of that will remain NI-free from April 2029, with contributions above that subject to both employer and employee NI.
Initially, middle-earners will not see a big difference to the cost of maintaining the same pension contributions – or lose much from the changes – but over the years the impact will compound.
Higher earners will see a more substantial immediate impact and a greater effect over the years. But basic rate earners pay a higher percentage of NI, at 8 per cent.
‘A deeply misguided move’
Retirement experts have heavily criticised the salary sacrifice cap arriving while the government is encouraging people to save more for retirement.
Jon Greer, head of retirement of policy at Quilter, says: ‘Introducing a £2,000 cap on National Insurance relief for pension salary sacrifice from 2029 is a deeply misguided move.
‘At a time when the Government acknowledges that tomorrow’s pensioners risk being poorer than today’s, policy should be focused on incentivising saving and not dismantling one of the most effective tools we have.’
Former Pensions Minister and partner at LCP, Steve Webb, says: ‘The decision not to implement this change until 2029 creates a huge opportunity for firms to restructure the way that they offer pay and pensions in order to mitigate or eliminate this new charge.
‘There is a high probability that this policy will only raise a fraction of the amount expected by the Chancellor.’
Mike Ambery, retirement savings director at Standard Life, says: ‘The Chancellor’s decision to cap salary sacrifice at £2,000 a year marks a significant shift in how people can save for retirement.
‘Salary sacrifice has long been one of the most efficient ways for workers to boost pension contributions, so limiting it will inevitably increase costs and reduce take-home pay for many.
‘The surprise today is that the changes will apply only to individual’s contributions and employer contributions will remain exempt from national insurance.
‘While the change is significant it is less damaging than feared and potentially creates a number of options for people to maintain their level of saving.’
Salary sacrifice curbed: Workers who exceed the cap will have to stump up more to end up with the same amount in their pensions
How much will it cost workers?
So what will the changes mean at your salary level? The numbers below were crunched by financial adviser Quilter.
Basic-rate taxpayers
Those earning £12,570 to £50,270 are taxed at 20 per cent on income above their personal allowance of £12,571, and pay National Insurance (NI) at 8 per cent.
Lower earners are likely to avoid the worst impact because most of their annual contributions will be under the cap.
A worker on £30,000 sacrificing 7 per cent or £2,100 of salary would need to pay an extra £8 into their pension to maintain contributions, according to Quilter’s calculations.
For someone on £40,000 a year, at a 7 per cent or £2,800 contribution you would put in £64 more.
Someone on £50,000 sacrificing 7 per cent, or £3,500, of their pay would have to add £120 more.
However, this will ratchet up over the years as your salary increases. Take someone on £35,000 a year now, who pays in 7 per cent or £2,573 a year into their pension, to maintain contributions they would have to pay in £46 more.
If their wage increased 5 per cent a year they would be on £42,543 by 2029/30. At that point a 7 per cent or £2,978 pension contribution would cost them £78 more.
Higher-rate taxpayers
The effect of a £2,000 salary-sacrifice cap on higher earners is greater. More people than ever are paying higher-rate tax of 40 per cent on pay of £50,271 to £125,140.
If you earn £75,000 you stump up £17,432 in income tax and £3,511 in NI.
Someone on £75,000 sacrificing 5 per cent of salary would have to pay an extra £35 in NI to get the same amount into their pension if a cap is imposed.
Sacrificing 8 per cent of salary would mean they have to pay in an extra £80.
The more you earn and put in your pension, the greater the hit if salary sacrifice is curbed.
Those on £100,000 pay £27,432 in income tax and £4,011 in NI.
If you earn £100,000 and sacrifice 5 per cent of your income for your pension, you would have to pay in an extra £60 yourself.
If you sacrifice 8 per cent of your salary you would have to pay in an extra £120.
Additional-rate taxpayers
Staff earning more than £125,140 face 45 per cent income tax. Those on £150,000, pay £53,703 in income tax and £5,011 in NI.
Under a cap, you pay an extra £110 in NI if you sacrifice 5 per cent of your salary.
If you sacrifice 8 per cent, you will have to pay an additional £200.
What about child benefit and the 60% tax trap?
Paying more into your pension can push you into a lower bracket – whether you do it via salary sacrifice or not – and can help you put off repaying student loans, or allow you to carry on receiving child benefit, or take you back below the £100,000 pay threshold.
Charlene Young, senior pensions and savings expert at AJ Bell, says: ‘Despite the NI savings being capped, pension contributions will still be exempt from income tax and workers can still enjoy pension tax relief up to their marginal rate of income tax.
‘More so, making pension contributions to schemes like self-invested personal pensions (Sipps) will still reduce a taxpayer’s “adjusted net income”, pulling them out of higher rate tax or one of the many punishing tax traps while also boosting their retirement savings.’
She explains that for someone with an adjusted net income of £60,000 or more, they will start to see any child benefit clawed back, while someone breaching the £100,000 limit starts to lose their tax-free personal allowance for the year.
‘In both cases, their extra earnings face an effective tax rate of 62 per cent if you include NI,’ says Young.
‘Pension contributions can reduce adjusted net income back down under these thresholds as the gross value of the pension contribution can be deducted from “adjusted net income.
‘This could mean tax relief of up 62 per cent on the money paid in if you can claw back child benefit or personal allowance, or even more if you consider the cliff edge for parents of young children.
‘Families where one person has income over £100,000 also lose their entitlement to tax-free childcare and extra funded childcare hours.’
Young says instead of making a formal arrangement to keep their salary below a certain level, workers will in future have to work out what extra pension contributions they need to make
‘This will involve a little bit of extra admin but will still be well worth it when you consider the potential tax savings on offer.’
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