Chancellor Rachel Reeves has ignited controversy with a confirmed tax raid on salary sacrifice schemes in her recent budget announcement, a move financial experts warn could decimate retirement plans for millions across the UK.
What is salary sacrifice and how does it work?
Salary sacrifice arrangements allow employees to exchange a portion of their pre-tax salary for a non-cash benefit from their employer. This can include pension contributions, a company car, or childcare vouchers.
By reducing your gross salary before income tax and National Insurance are calculated, these schemes lower your overall tax bill and can increase your immediate take-home pay. Employers also benefit by saving on their own National Insurance contributions on the sacrificed amount, with some choosing to reinvest this saving into the employee's pension pot.
For example, an individual earning £50,000 annually who sacrifices 5% (£2,500) into their pension would only be taxed on £47,500. This not only reduces their tax liability but often comes with an employer pension top-up, making it a powerful tool for long-term savings.
The budget change: A new £2,000 cap
The central reform announced by the Chancellor is a new annual limit. From now on, only the first £2,000 of sacrificed salary will be exempt from National Insurance. Any contributions above this threshold will be treated as ordinary employee pension contributions, subject to both employee and employer National Insurance.
According to the Office for Budget Responsibility, this policy is projected to raise £4.7 billion in the 2029/30 tax year and £2.6 billion in 2030/31.
While those earning up to £40,000 and making minimum pension contributions are unlikely to be affected, higher earners will feel the pinch. Financial services firm Fidelity provided a stark illustration: someone earning £105,000 sacrificing £10,000 to stay below the £100,000 tax threshold would now face an extra £160 in annual NI, with their employer paying an additional £1,200.
Experts sound the alarm on pension black holes
The financial industry reacted with alarm ahead of the budget. The Association of British Insurers and major pension providers had urged the government to reconsider, cautioning that the next generation of retirees is already at risk of being poorer than today's pensioners.
Yvonne Braun, director of policy for long-term savings at the ABI, stated that capping salary sacrifice would mean "speedwalking into a retirement crisis." Analysis from AJ Bell conducted before the announcement quantified the potential damage: a 35-year-old earning £50,000 could see a £22,060 shortfall in their pension by age 65. This black hole escalates to over £37,000 for someone on £75,000 and nearly £50,000 for a £100,000 earner.
Money Clinic podcast host Claer Barrett had warned her followers that the move would be particularly damaging for working parents navigating "horrible cliff edges in the tax system" and would "decimate" younger workers' prospects for a decent retirement.
Three steps to protect your finances now
In light of the changes, financial experts recommend taking proactive steps to safeguard your retirement savings.
Andrew Prosser, head of investments at InvestEngine, suggests employees should:
- Review workplace pensions and maximise employer contributions wherever possible.
- Consider topping up pensions using any remaining annual allowance.
- Coordinate allowances with a spouse or civil partner to shelter more income from tax.
This budget decision marks a significant shift in the UK's savings landscape, placing a greater burden on individuals to actively manage their financial futures in the face of changing fiscal policy.
