Rachel Reeves, the Shadow Chancellor of the Exchequer, is proposing radical reforms to “salary sacrifice” pension plans. So with this vision, she is clearly preparing for the next budget announcement. These initiatives give employees the tools to significantly increase their retirement savings. They can pay into their pensions before these income tax and national insurance (NI) deductions. As the new policy threatens to impose some hard cap on these schemes, both employees and employers could be in for a rude financial awakening.
The idea of “salary sacrifice” allows staff to put more of their salary, before tax, straight into their pensions. These processes make their taxable income lower, which means they are paying less income tax and NI contributions. As a result, employees save more, with tax relief depending on the employee’s income tax band. For individuals paying income tax at the higher rates, contributing through this scheme can deliver even more tax reliefs of more than 20%.
Understanding Salary Sacrifice Benefits
Employees benefit from expanded savings due to tax relief. Meanwhile, employers have an incentive, as they save National Insurance contributions on the amounts sacrificed. For instance, if “salary sacrifice” were to be abolished, an employee earning £55,000 annually who contributes 10% (£5,500) to their pension would see a reduction of approximately £441 in take-home pay. And employers would pay an additional £825 in NI contributions.
As discussions unfold regarding the budget, Reeves and her team must weigh the potential revenue generation against the adverse effects on pension savers and businesses. The Treasury could therefore be looking to raise at least £2 billion per year through implementation of a cap on these schemes. We argue that such a measure would negatively impact employees’ long-term retirement savings and significantly raise costs for employers.
“What you’re effectively doing is penalising those employers that actually contribute more to employees’ pensions.” – Amanda Blanc, chief executive of Aviva
Current Position on Tax-Free Cash and Pension Contributions
According to reports, limitations on tax-free employer cash remain very much off the table for this budget cycle. Build Back Better As indicated above, despite this, “salary sacrifice” schemes are still a buzzword topping the agenda. Advocates for maintaining these schemes caution against any changes that may discourage pension savings among employees, particularly in a country where nearly 15 million individuals are not saving adequately for retirement.
Amanda Blanc, chief executive of Aviva, expressed worries about punishing people who pay in more through these plans. She warned that putting people off pension savings might have long-lasting harmful effects on the UK economy.
“But you’re also saying to people who save for their pension that perhaps they shouldn’t do it, and I think that’s bad news long-term for the UK if you think about the fact that 15 million people in the UK are not saving enough.” – Amanda Blanc, chief executive of Aviva
We were joined by Charlene Young of AJ Bell to provide an update. As the FT reported, this is because the Treasury has ruled out ending “salary sacrifice” schemes for now. She highlighted that plans to cap the amount of earnings eligible for NI exemptions are ongoing negotiations. That discussion is still changing and developing.
“Rather than an all-out ban on using salary sacrifice, one option on the table is a £2,000 cap on the amount of earnings that can be exchanged for pension contributions that benefit from a national insurance exemption.” – Charlene Young
Implications for Employees and Employers
Change to “salary sacrifice” pension schemes would dramatically change the landscape on how employees save for retirement. These changes can have a big impact on how employers choose to control their payroll costs. The advocacy discussions about these changes highlight an important balance. We aren’t in that position right now, but we’ll need to raise revenue for the federal government and save pensions at the same time.
As the date for a budget agreement draws near, stakeholders from every sector are watching closely. They are especially anxious to see how Reeves’ proposals will affect the fiscal landscape. The implications extend beyond mere savings; they touch on broader economic health and the well-being of millions of workers across the UK.