Six-figure earners could see up to £50,000 wiped from their future retirement pots if the chancellor presses ahead with plans to curb salary sacrifice pension arrangements, new analysis suggests.
Salary sacrifice currently allows workers to give up part of their salary in return for pension contributions before income tax or national insurance are applied, making it one of the most efficient ways to save.
Employees can contribute up to £60,000 a year without tax penalties, and many benefit from National Insurance savings of up to eight per cent.
Rachel Reeves is now expected to cap at £2,000 the amount of salary that can be sacrificed before National Insurance charges apply. Those earning below £50,270 would pay eight per cent National Insurance on anything above the cap, while higher earners would face an additional two per cent.
The change could dramatically reduce long-term pension growth for middle and high earners, with modelling showing losses running into tens of thousands by retirement.
Treasury officials are examining the cap as part of wider pension reforms ahead of the November 26 Budget. The move could raise around £2billion a year, offering a significant boost to public finances while allowing Labour to avoid breaching its manifesto pledge not to raise major taxes.
Several options remain on the table as the Treasury looks for revenue-raising measures that stay within its political commitments.
Workers across various income brackets face significant reductions to their retirement funds under the proposed changes, with AJ Bell’s analysis revealing potential losses ranging from £20,000 to nearly £50,000.
A 35-year-old currently earning £50,000 annually could see their pension pot diminished by £22,060 upon reaching retirement at 65, based on calculations assuming existing savings of £30,000 and combined employer-employee contributions of eight per cent.
Higher earners face even steeper losses, with those on £75,000 salaries potentially missing out on £37,201, whilst individuals earning £100,000 could lose £49,682 from their retirement savings.
The projections, which factor in five per cent investment growth, demonstrate that workers earning £40,000 would also be affected, facing a £20,101 reduction in their pension wealth by retirement age.
Charlene Young, Senior Pensions and Savings Expert at AJ Bell, cautioned that whilst the measures avoid direct taxation, workers would experience diminished take-home earnings alongside reduced retirement savings.
“Although clamping down on salary sacrifice isn’t an explicit tax rise, many employees will see less in their pay packets and ultimately their pension pots too,” Ms Young stated.
The timing proves particularly challenging given unemployment has reached its highest levels since the pandemic, with businesses potentially struggling to absorb additional financial burdens.
Ms Young highlighted that employers currently benefit from 15 per cent National Insurance savings on sacrificed salary amounts, with some firms passing these advantages to staff through enhanced pension contributions.
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The proposed £2,000 salary sacrifice cap would not only hit higher earners. Workers on £40,000 who pay the minimum five per cent into their pension across their full salary would also be affected, meaning even ordinary savers could be pulled into the changes.
Businesses would also face significant costs. Employers would have to pay more in National Insurance and deal with new administrative work to apply the cap. This could mean updating payroll systems and rethinking how they structure staff benefits.
Charlene Young warned that some firms may decide to scrap salary sacrifice schemes altogether rather than deal with the extra admin. If that happens, workers could see an even bigger hit to their pension savings.
A simple example shows the impact. An employee earning £55,000 and paying 10 per cent into their pension would cost their employer an extra £525 a year under the £2,000 cap, and the employee would take home £118 less. If salary sacrifice was removed entirely, the employer’s extra cost would jump to £825 and the employee’s take-home pay would fall by £441.
Workers retain access to income tax relief on pension contributions regardless of salary sacrifice restrictions
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GETTYWorkers retain access to income tax relief on pension contributions regardless of salary sacrifice restrictions, offering alternative strategies for managing their tax obligations.
Individuals can reduce their adjusted net income through pension contributions to sidestep various tax penalties, though this requires additional planning compared to salary sacrifice arrangements.
Those earning above £60,000 begin losing child benefit through clawback mechanisms, whilst earners exceeding £100,000 forfeit their annual tax-free personal allowance.
Ms Young noted that both scenarios create an effective 62 per cent tax rate including National Insurance, with parents facing particularly severe consequences at the £100,000 threshold where eligibility for tax-free childcare and additional funded childcare hours vanishes entirely.
Strategic pension contributions remain valuable for escaping these tax traps whilst simultaneously building retirement wealth, despite requiring more administrative effort from savers.