OBR Warns Millions More Workers Could Face Pension Tax Impact Under Reeves' Salary Sacrifice Cap
The Office for Budget Responsibility (OBR) has issued a stark warning that millions more individuals could be affected by Chancellor Rachel Reeves' proposed changes to workplace pensions than originally anticipated. The government's plan to introduce a £2,000 annual cap on salary sacrifice pension contributions from 2029 could have far-reaching consequences for both employees and employers across the United Kingdom.
Expanding Impact Beyond Initial Estimates
When the policy was announced in November's Budget, initial projections suggested that approximately 44 percent of workers utilizing salary sacrifice arrangements would be impacted, equating to around 3.4 million individuals. However, fresh analysis from the OBR now indicates that an additional 4.3 million people could find themselves affected by the changes, even if they don't typically earn enough to breach the £2,000 annual allowance threshold.
The uncertainty stems from how businesses might respond to the new limitations. The OBR has emphasized that employer reactions remain "highly uncertain," with potential responses including reducing employees' contractual salaries in exchange for increased pension contributions from the company itself.
How Salary Sacrifice Currently Works
Under existing arrangements, salary sacrifice schemes allow workers to contribute to their pensions before their salaries are subject to National Insurance and income tax deductions. This creates a tax-efficient method for retirement saving while simultaneously reducing overall tax liabilities. For example, an employee earning £40,000 annually and contributing five percent toward their pension—a common starting point under auto-enrolment—would reach the proposed £2,000 limit immediately.
This means any future salary increases, additional pension contributions, or career moves to higher-paying positions would result in increased National Insurance payments for affected workers from 2029 onward.
Employer Dilemmas and Alternative Options
While employee contributions face the new cap and subsequent taxation, company contributions remain unaffected and can be increased without additional costs beyond the pension amount itself. However, regulations require that any such adjustments must be applied uniformly "across the workforce," potentially limiting implementation for some organizations.
Tom Selby, director of public policy at investment platform AJ Bell, highlighted the challenges facing businesses: "A significant unknown danger in capping salary sacrifice was always, and remains, the reaction of employers offering these arrangements. Some may simply decide that offering salary sacrifice is no longer worth it, while others could simply pare back pension contributions or other forms of remuneration to make the numbers add up."
Selby further explained that companies essentially face three options: absorb the additional costs, reduce investment plans, or pass expenses on to employees through lower compensation.
Alternative Pension Arrangements and Financial Implications
Relief at source (RAS) schemes present another potential pathway for pension contributions. Under this system, workers would need to file self-assessment tax returns to reclaim additional pension tax relief if they are higher or additional-rate earners. The OBR notes this could lead to approximately £0.2 billion in additional annual Treasury revenue from 2030 onward, partly due to unclaimed relief when individuals fail to reclaim entitled funds.
The OBR's calculations incorporate assumptions that employers will attempt to pass 50 percent of additional costs to employees through reduced ordinary employer contributions (which aren't taxed) and 50 percent through lower salaries and bonuses (which are taxed).
Practical Advice for Affected Workers
For employees currently utilizing salary sacrifice arrangements who anticipate being affected by the changes, Selby recommends proactive engagement with employers: "Employees currently in salary sacrifice arrangements who will be affected by the decision may want to have a conversation with their employer to ensure they are making the most of the benefit while they still can."
He also clarified alternative approaches: "It's important to remember that, in relation to things like free childcare, salary sacrifice isn't the only way to reduce your salary below that key £100,000 threshold—personal pension contributions are also subtracted from your adjusted net income measure when determining whether you qualify or not."
Despite the concerning projections, Selby offered reassurance: "But fundamentally, there is no need for anyone to panic about this—you will still get income tax relief on your pension contributions from 2029 and firms will still be required to 'match' contributions in your workplace pension scheme."
The OBR's expanded warning underscores the complex ramifications of pension policy changes, highlighting how initial estimates often fail to capture the full scope of impact on both workers and businesses navigating the evolving retirement savings landscape.
