Rachel Reeves is expected to announce a smorgasbord of tax rises at the budget today but one decision in particular has really got people talking: a reported tax raid on salary sacrifice schemes.
Concerns have been raised that such a move could put people’s retirements at risk and push them into paying more tax.
Money Clinic podcast host Claer Barrett warned her Instagram followers that younger workers’ prospects of saving for a decent retirement would be “decimated” and it would be particularly bad for working parents who are trying to stay below “horrible cliff edges in the tax system”.
But it’s not just pensions that could be affected.
Here we explain what salary sacrifice is, how it works, what Reeves is reportedly considering and why all of that is important for the money in your pocket.
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What is salary sacrifice?
Salary sacrifice schemes allow people to give up a chunk of their salary for a different benefit from their employer.
This could be for a company car, a cycle to work programme, childcare vouchers, healthcare or a pension.
When you give up some of your salary, you do not pay income tax or national insurance on that amount, as it’s taken out of your gross salary before the taxes are calculated.
This can help bring your overall tax bill down and boost your take-home pay.
It’s helpful for your employer as well, as they don’t have to pay national insurance on the amount you sacrifice either.
Some employers choose to add this saving to your pension as well.
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Here’s an example to explain how it works
Let’s say you earn £50,000 a year and you choose to sacrifice the minimum amount of 5% into your pension.
Each year, your employer would pay £2,500 of your salary into a pension, and your official salary becomes £47,500.
Your employer has to top up your pension by a minimum of 3%, so you get an extra £1,500 a year in your retirement fund, taking the total to £4,000 paid by your employer.
You would only pay national insurance and income tax on the remaining £47,500, so your tax bill would be £9,780.40 a year and your take-home pay would be £37,719.60.
If you didn’t use salary sacrifice but paid the same amount into your pension, your tax bill would be £9,980.40 and your take-home pay would be £37,519.60.
And your employer would save £345 on its national insurance bill, paying £5,299.20, instead of £5,644.20.
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“Employees in workplace pension schemes will usually see three main payments deducted from their monthly salary before receiving their take home pay – income tax, employee NI and pension contributions. The same overall amount still goes into their pension, but depending on what type of scheme you’re in, your pension contributions may come out first, second, or third,” Charlene Young, pension and savings expert at AJ Bell, says.
“Crucially, both methods of income tax relief mean your own pension contributions are taken from your pay after your NI contributions have been deducted. But salary sacrifice rules let you make your own pension payment before interference from both NI and income tax.
“The main benefit to pension savers is that employee NI does not eat into their contributions. But the agreements do involve a cut on paper to someone’s pay, which could be important when it comes to things like being approved for a mortgage.”
What is Reeves going to do?
The chancellor is reportedly considering capping the amount of salary a person can sacrifice without paying national insurance at £2,000 a year.
Some suggestions have been made that the change could raise up to £4bn for the government.
For those earning up to £40,000 a year and sacrificing the minimum 5% into their pension, nothing would change, since the amount they are contributing would remain within the limit.
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But for higher earners, who are more likely to use salary sacrifice to bring down their tax bill, it could have a major impact.
Financial services company Fidelity has a helpful example:
The Association of British Insurers and major pensions providers have urged Reeves not to take that step, warning the next generation of retirees is already at risk of being poorer than today’s.
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.
Yvonne Braun, director of policy, long-term savings at the ABI, says: “The industry has long-warned that we’re ‘sleep-walking’ into a retirement crisis. If the government goes ahead with suggestions to cap salary sacrifice, then we’re no longer sleepwalking, we’re speedwalking.”
Analysis by AJ Bell suggests someone aged 35 earning £50,000 a year could face a hole in their pension of £22,060 by age 65 under the plans.
The black hole rises to more than £37,000 or even nearly £50,000 if they are already a higher earner on £75,000 or £100,000 respectively.
