Concerns have been voiced that millions of workers could be hit with a stealth tax raid on their pensions, amid fears that the Treasury is plotting a cash grab through sweeping reforms to salary sacrifice schemes. Salary sacrifice is an arrangement where an employee agrees to give up (or “sacrifice”) part of their gross salary in exchange for a non-cash benefit from their employer – typically, a pension contribution or a company car.
This allows them and their employer to make a saving on both income tax and National Insurance contributions on the sums that are “sacrificed”. In a move branded “very revealing” by former pensions minister Sir Steve Webb, HMRC has quietly published research exploring ways to cut back tax and National Insurance perks that currently benefit those saving into workplace pensions.
Experts warn the plans could leave the average earner £560 worse off each year. The findings come amid mounting pressure on Chancellor Rachel Reeves to plug a black hole in the public finances – estimated to be as much as £30billion – left by expensive benefit pledges, soaring borrowing costs and global economic turbulence.
The controversial plans, revealed in a little-publicised HMRC report, test employers’ reactions to three drastic shake-ups of salary sacrifice, a system used by half of UK firms to help staff boost their retirement pots by cutting income tax and NI bills.
One option would see both tax and National Insurance exemptions scrapped altogether, hammering both workers and bosses. A typical employee on £35,000 a year would lose £560, while their employer would be stung for an extra £241.
A second scenario involves removing only National Insurance relief, still costing workers over £200 and employers the same. A third, more modest proposal, would axe NI breaks only on contributions over £2,000 – affecting higher earners but still deterring many from saving more.
‘This would be bad for everyone’
Sir Steve Webb, now a partner at pensions consultancy LCP, said: “It is very revealing that HMRC has paid for research into the likely response from employers if salary sacrifice for pensions were to be scaled back. Although the research was commissioned under the previous government, the desire to raise additional revenue is, if anything, even more acute today.
“With a Chancellor reportedly looking to make up a multibillion-pound hole in the public finances in her autumn Budget, this research suggests that changes to salary sacrifice are firmly on the agenda, and likely to be considered as a potential revenue-raising measure.”
Critics say the move would hit savers with a ‘double whammy’ – either pay more into their pensions now or face a far smaller nest egg in retirement.
Jonathan Watts-Lay, of retirement specialists Wealth at Work, said: “It would be bad for everyone. Whether they just do National Insurance or National Insurance and income tax, the fundamental of all those scenarios is that [people] have less money going into their pension unless they up their contributions.
“You’re basically saying to someone you either need to pay more money, or you carry on and your pot will be smaller when you get to retirement. There’s no positive impact of it. They either take the pain, or they take the pain when they get to retirement.”
Why do people use salary sacrifice
The shock proposals follow reports that high earners are increasingly using salary sacrifice to lower their taxable income and avoid breaching thresholds that bring punishing tax rates or the loss of state perks like free childcare.
Currently, going just over £100,000 can see workers hit with an effective tax rate of 60% and stripped of their entitlement to 30 hours of free childcare. Meanwhile, Labour’s growing list of benefit pledges – including a review of the two-child benefit cap and restoring winter fuel payments to all pensioners – is adding to the strain.
The National Institute of Economic and Social Research (NIESR) warned this week that Reeves could be forced to raise up to £30billion in the autumn Budget to meet her promises – despite a manifesto pledge not to raise income tax, NI or VAT.
The HMRC research, carried out with 51 employers last year but only just released, reveals most firms view salary sacrifice as a valued part of their benefits package that helps retain staff. Some pass NI savings back to employees; others absorb them.
But the reaction to potential reforms was overwhelmingly negative. Employers warned that scrapping tax and NI breaks would “eliminate the benefit” of offering salary sacrifice at all. As a backbencher, Rachel Reeves once campaigned to scrap higher rate pension tax relief in favour of a flat 33% – raising fears among savers that she may still favour a crackdown.
A Treasury spokesman said: “These claims are totally speculative. HMRC regularly commissions independent research on all aspects of the tax system. We are committed to keeping taxes for working people as low as possible.”
