How salary sacrifice schemes changes in Rachel Reeves’ Budget will affect you

Salary-sacrificed pension contributions above £2,000 a year will no longer be exempt from national insurance (NI) from April 2029, according to a leaked document revealing Rachel Reeves’ budget minutes before she unveiled it.

The significant tax overhaul has prompted fears that some people’s retirement savings could be jeopardised.

Here we take a look at how salary sacrifice schemes for pensions work.

Salary sacrifice schemes permit individuals to exchange a portion of their earnings for an employer-provided benefit.

Often integrated into pension plans, this offers a tax-efficient route for workers to enhance their retirement savings.

When contributing this way, the employer deposits the entire sum – including their own contribution – directly into the employee’s pension fund.

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The Office for Budget Responsibility (OBR) document said that salary-sacrificed pension contributions above £2,000 would be treated as ordinary employee pension contributions in the tax system and therefore be subject to both employer and employee national insurance contributions.

The document said: “The policy results in an increase in NICs (national insurance contributions), which is estimated to raise £4.7bn in 2029/30 and £2.6bn in 2030/31.

“The costing assumes that, in most cases, employee pension contributions above £2,000 that were part of a salary-sacrifice scheme will become subject to employer and employee NICs, either because they move to a standard pension scheme or continue in a salary-sacrifice scheme under the new tax arrangements.”

As an example, someone on a £40,000 a year salary who contributes 5 per cent of that into a pension scheme would be adding the limit of £2,000 – so upping their contribution rate, receiving any kind of raise or a lower than expected threshold would all mean they begin paying NI on a portion of it.

The average UK salary is £35,000; if someone on this is paying 6 per cent, they would be over the threshold by £100, so that portion would be subject to NI payments.

Salary sacrifice enables people to maintain their take-home pay, as people end up paying lower national insurance (NI) contributions.

There are also NI advantages for employers, helping them to offer more generous workplace benefits.

A lower salary on paper might affect some borrowing applications, such as for mortgages.

However, employers can maintain a “reference salary”, which may be considered.

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Reducing the use of the schemes would mean more government revenue, with some reports suggesting between £2bn and £4bn could potentially be raised, depending on how salary sacrifice is curbed.

But the Association of British Insurers (ABI) and major pensions providers have been urging chancellor Rachel Reeves not to take such a step, pointing out that the next generation of retirees are already at risk of being poorer than the current pensioner population.

Pensions industry bodies have warned that it could mean people and employers cutting back on the amounts going into pensions, storing up problems for pension savers and putting more cost pressures on businesses.

The ABI and the Reward and Employee Benefits Association (REBA) have warned that such a step would place additional strain on businesses and push millions of people into poorer retirements.

Yvonne Braun, director of policy, long-term savings at the ABI, said on Saturday: “The industry has long-warned that we’re ‘sleepwalking’ into a retirement crisis.

“If the government goes ahead with suggestions to cap salary sacrifice, then we’re no longer sleepwalking, we’re speed-walking.”

There are also concerns that the growing cost of employment will mean fewer businesses look to hire people, or else do not replace staff who leave. The British Chambers for Commerce had repeatedly warned the chancellor that firms were unable to bear any more tax burdens following raises to minimum wage and National Insurance contributions previously.

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Many people are already thought to be heading for a tough retirement financially and facing a sharp drop in their living standards when they stop work.

Although automatic enrolment has brought millions of people into pension saving, there are fears that too many workers are not saving enough to give themselves a comfortable retirement.

Workers saving into a pension nowadays are often bearing the risk as to how much money they will end up with in retirement, depending on factors such as how much they and their employer contribute and investment performance.

Pensions which promise savers a salary-based payout in retirement have become much less common in the private sector, putting the burden on the individual saver.

Cost of living squeezes in recent years have also had an impact on people’s ability to save into a pension.

Against such a backdrop, it has been argued that curbing salary sacrifice would make the situation worse. Workers are already seeing their salaries squeezed by frozen income tax thresholds, dragging people into higher tax bands.

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Some 13 million pensioners are set to see their state pension increase faster than inflation next April, due to the triple lock used to calculate state pension increases.

Under the triple lock guarantee, the state pension increases every April in line with whichever is the highest of total earnings growth in the year from May to July of the previous year, Consumer Prices Index (CPI) inflation in September of the previous year, or 2.5 per cent.

Next year’s expected 4.8 per cent increase – in line with wages – means that people receiving the full new state pension could get £241.30 per week – or around £12,548 per year.

Those on the full basic state pension could see their weekly payment rise to around £184.90.

Many pensioners do not receive the full state pension.

Steven Cameron, pensions director at Aegon, said: “While welcome, the increase does come with a sting in the tail for future years. Under the triple lock, the full state pension will increase by a minimum of 2.5 per cent in future years, meaning in 2027/28 it will be at least £12,861.

“This is above the personal allowance of £12,570, which is already frozen until April 2028, with speculation of an extended freeze until 2030.”

He added: “Those with solely a state pension could face receiving letters from the taxman demanding they pay the tax due.”