Chancellor Rachel Reeves is thought to be considering a significant change to pension tax relief that could raise £16billion annually.
The plan involves removing National Insurance (NI) relief on employer contributions to pension schemes which would help plug the £22billion black hole, new reports have shown.
This potential move targets a system that currently exempts employer pension contributions from NI, costing the Government nearly £24billion per year in foregone revenue.
These proposals have been put forward by Steve Webb, former pensions minister and his partners at pensions consultancy Lane Clark & Peacock (LCP). His team have put out a report trying to work out where the Chancellor’s tax axe might fall on pensions.
Commenting on the report, Bloomberg’s John Stepek said: “Of the near-£50billion that pensions-related tax relief is estimated to “cost” the Government each year, almost half (just under £24billion) is down to foregone employer NI contributions.
“That’s a full ‘black hole’ plus a bit on top! No wonder Rachel Reeves might be eyeing it up.”
However, he explained the actual revenue raised would likely be closer to £16billion, as public sector pensions would need to be excluded from the changes.
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The current system allows employers to make pension contributions without incurring NI charges
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The current system allows employers to make pension contributions without incurring NI charges, which has led to widespread use of salary sacrifice arrangements.
Under salary sacrifice, employees accept a lower salary in exchange for higher employer pension contributions, reducing overall NI liabilities.
LCP’s report explained: “Employees pay a rate of eight per cent on a band of earnings between £242 and £967 per week, and two per cent thereafter. Employers pay at a rate of 13.8 per cent on all earnings above £175 per week.”
This NI relief on employer pension contributions is an attractive target for revenue raising due to its significant cost to the Treasury. It also addresses what some view as a loophole in the tax system that allows companies to structure remuneration packages to minimise NI payments.
The potential change could affect both employers and employees, particularly those benefiting from salary sacrifice arrangements.
LCP’s report highlighted that such a change could “almost certainly” be introduced relatively quickly, without the need for years of phasing or transitional rules which could provide an immediate boost to public finances.
The measure also has political appeal. Stepek explained it would avoid any further conflicts with public sector workers and the initial impact would fall on employers rather than individual voters, potentially softening public backlash.
The change could be framed as closing a tax loophole and promoting fairness between firms that offer salary sacrifice and those that don’t.
However, there are concerns about taxing an activity the Government presumably wants to encourage – employer pension contributions. Critics argue it could discourage employer pension contributions and potentially impact employees’ future retirement savings.
Despite its potential benefits, LCP’s report noted: “One of the Government’s key missions is to promote economic growth, and a multi-billion pound tax increase on businesses might not sit well with that priority.”
The change could particularly impact struggling employers making payments to clear deficits in Defined Benefit pension schemes.
Stepek warned: “To be very clear, if the Government does go ahead with this, then it’s yet another tax on private sector employment. You may not feel it immediately, but you will probably feel it in your next pay review.”
The proposal could also widen the disparity between private and public sector pensions, potentially creating new inequalities in the workforce.
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Stepek concluded: “But unfortunately, this idea enjoys the golden political combination of raising quite a lot of money in a short period of time while being hard for anyone to sum up in a punchy newspaper headline.
“That makes it definitely one to watch out for, I’m afraid.”
The £48.7billion cost of pension tax relief in 2022/23 makes it an attractive target. However, any changes must balance the need for revenue with potential impacts on pension savings and business growth.
The October 2024 Budget is expected to include both spending cuts and tax rises to improve public finances, with this pension raid potentially playing a significant role.
