Rachel Reeves will announce a stealth tax raid on retirement savings, a move experts said would reduce take-home pay and cut the size of pension pots.
The chancellor is expected to use the budget to limit a tax break on pension contributions for both employers and employees to raise up to £2 billion a year.
There are concerns that the crackdown will penalise people for “trying to do the right thing” and save for their retirement as well as being detrimental to company pension schemes.
Reeves has decided not to cut pension lump-sum withdrawals due to concerns about the impact on pensioners. It means people who retire will be able to continue making tax-free drawdown payments worth 25 per cent of a total pension pot up to a maximum of £268,275.
The chancellor will instead target salary sacrifice schemes as she attempts to fill a gap in the public finances of up to £30 billion.
This week she told the budget watchdog that she planned to increase income tax, which would be a breach of Labour’s manifesto.
Lucy Powell, the deputy leader of the Labour Party, has warned Reeves that breaking the pledge not to raise income tax would erode the public’s trust.
Lucy Powell, Labour’s deputy leader, said that breaking the pledge not to raise income tax would erode public trust
THE TIMES PHOTOGRAPHER JAMES GLOSSOP
On Monday, the Office for Budget Responsibility will deliver its verdict on the “major measures” in the autumn statement.
The Treasury is concerned that the impact of growth measures such as planning reforms and trade deals, measures that would increase the need for tax rises, will be excluded from the forecast.
Tax breaks on pension contributions are seen as “low-hanging fruit”.
At present there is no limit on the amount that an employee can put into their pension under salary sacrifice schemes before it becomes subject to national insurance. The schemes take money out of people’s pay packets before they are subject to tax.
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Reeves is expected to use the budget to cap the amount of someone’s salary that can be sacrificed without incurring national insurance payments at £2,000 a year.
Any pension contributions over that level would result in an employee paying the full rate of national insurance of 8 per cent on a salary of less than £50,000 and 2 per cent on income above that.
The change will hit workers who use salary sacrifice schemes to pay more than £2,000 into their workplace pension, with employees recommended to save at least 15 per cent of their salary for retirement.
A basic-rate taxpayer earning £50,270 who puts aside 6 per cent of their salary would pay £80 more in national insurance a year. If they chose to set aside £5,000, equivalent to 10 per cent of their salary, the national insurance hit would be £240.
Pensions experts warned that many employees would face a double hit as companies would also lose the tax break that allows them to fund generous employer pension contributions.
Currently, any firm that runs a salary sacrifice pension scheme does not pay the 15 per cent employer national insurance tax on the proportion of salaries that go into workers’ pensions.
Under Reeves’s plan, that exemption would be limited. As a result the cost to a company for a worker earning £50,270 and putting 10 per cent of their salary into a pension would be £450 more a year.
Steve Webb, partner at pension consultants LCP, said: “Salary sacrifice schemes have been around for a long time and are a way of encouraging employers to offer good workplace pensions.
“Introducing a cap would increase national insurance bills mostly for employers and hits the very firms who are doing the right thing.
“Once a cap is in place, there will be a widespread expectation that this is the thin end of the wedge and eventual abolition is on the cards. At a time when we need workers and firms to put more focus on pensions, this would be a seriously backward step.”
Steve Hitchiner, chair of the Society of Pension Professionals tax group, warned that this meant many employers would be forced to reduce the generosity of their pensions scheme to claw back the additional tax.
“This change will significantly increase the cost to employers who are providing pension salary sacrifice arrangements to their workers, as they will be liable to pay 15 per cent national insurance on any contributions paid by their employees via salary sacrifice,” he said.
“Firms are unlikely to be able to absorb this cost, and our expectation is that this will be passed down to employees, through less generous employer pension contributions or smaller pay rises.”
Research by HM Revenue & Customs which found strong opposition to the change among businesses.
Firms told the government it would result in a “reduction of benefits” for their workers and could “disincentivise saving into a pension”.
They also warned that it would be “likely to affect employee morale as they would have to face additional charges of NI that they had previously not incurred”.
One company told the researchers that they would be left to explain to their employees “why their payslip is going to be varying so much when as far as they’re concerned, their earnings haven’t moved materially.
Another added: “They [the government] are looking at how they can increase their revenues through the back door.”
Some employers said that depending on the impact of the changes they could stop offering salary sacrifice schemes altogether.
Analysis
By Mary Downer
You can currently save up to £60,000 into your pension every year without paying any income tax on contributions.
A third of private sector employees use salary sacrifice schemes to save into their pensions before tax is deducted, according to the Society of Pension Professionals. This allows both employee and employer to save on national insurance contributions.
If the government capped national insurance savings on pension contributions at £2,000 it would hit higher earners the hardest. A worker earning £45,000 who saves 5 per cent of their salary would have to pay £30 more in national insurance and their employer £34.
However, someone earning £125,000 who saved £25,000 of their salary into their pension through salary sacrifice could have to pay £460 more in employee national insurance, and their employer £3,450, according to the accountancy firm RSM.
Those earning between £100,000 and £125,140 have tended to rely on salary sacrifice schemes to offset the impact of punishing tax cliff edges which mean they can face a marginal tax rate of over 60 per cent. After earning £100,000, employees start to lose their tax-free personal allowance at a rate of £1 for every additional £2 earned.
For parents, the cliff edge is even steeper as tax-free childcare allowances are forfeited, and free childcare hours are halved. Many of these parents use salary sacrifice to reduce their tax burden, as the £100,000 threshold is based on “net adjusted income”, calculated after tax and salary sacrifice.
A cap on NIC relief on salary sacrifice could cost these parents thousands in pension savings, providing such schemes continue to run after the tax savings for employers are slashed.