New OBR figures show millions more workers at risk of losing out following Budget changes to ‘salary sacrifice’ for pensions

Analysis published today (5th Feb) by the OBR, in response to a request from LCP partner Steve Webb, has revealed that the scale of losses from the Budget changes to salary sacrifice could be much wider than previously expected.

Under the Budget changes, from 2029/30, any employee pensions contributions in excess of £2,000 paid by salary sacrifice will be subject to employer and employee National Insurance Contributions. The policy is expected to raise £4.8bn in 2029/30.

According to previous Government analysis, published shortly after the Budget, around 7.7m employees currently use salary sacrifice to make pension contributions and, of these, around 3.3m sacrifice more than £2,000 of salary or bonuses.

From this, the Government has previously argued that only these 3.3m people are adversely affected. For example, the same HMRC policy paper says:

“This means 44% of employees using salary sacrifice for pensions would be impacted by this measure, while 56% around 4.3 million people are fully protected by the £2,000 threshold.” (emphasis added)

However, the new OBR analysis reveals that many of these 4.3m workers sacrificing less than £2,000 could also lose out.

The reason for this is that employers are expected to respond in a variety of ways to this major tax-raising measure, and several of these could create losses amongst those who currently contribute less than £2,000. These come under three headings identified by the OBR:

• Employers switching to ordinary contributions: OBR say: “Employers could look to formalise salary-sacrifice arrangements to replicate the tax benefits of salary-sacrifice by increasing contributions in place of wage growth or lowering contractual salary in exchange for higher employer contributions”. In this case, workers who pay less than £2,000 could also lose because of ‘lower wage growth’ (ie lower future pay rises) or “lower contractual salary”. As OBR say, employers would have to do this for the whole workforce, not just higher earners: “the employer must take an ‘across the workforce’ approach to increased generosity of employer contributions and a proportionate reduction in pay”.
• Employees switching to relief at source (RAS) schemes: in this case, salary sacrifice ends and workers move to making normal pension contributions, including workers paying in less than £2,000; as there is no longer any salary sacrifice, they face an increased NICs bill compared with the current situation; those who end up in what are called ‘relief at source’ schemes face an additional issue in that they will now have to claim back any higher rate relief that they are entitled to.
• Pass-through: with any increase in employer costs, there is a high likelihood that employers will pass on some of this cost to employees in the form of lower wages or lower pension contributions or both; OBR assume that around three quarters (76%) of the hit on employers will be passed through, mainly via lower wages; this will, again, hit people who are under the £2,000 contribution level.

In summary, the OBR Budget analysis assumes a major behavioural response by employers to this big tax increase. Several of the ways in which employers might respond will hit the 4.3m people contributing less than £2,000, a group the Government has previously said were ‘protected’.

Commenting, Steve Webb, partner at LCP, said:

“The Budget change to salary sacrifice rules around pensions was a huge measure which will cause employers to rethink their pay and pensions policies. The independent OBR shows very clearly that there are a range of ways in which employers will respond which will affect the wider workforce and not just those contributing over £2,000 via salary sacrifice. Far from ordinary workers being ‘protected’ from the changes, we could see millions of people on modest incomes losing out as well, further undermining their incentive to save in a pension. We urgently need the Government to be clear about the true scale of the losses from this policy and not continue to suggest that ordinary workers will not be affected.”