£16 Billion Tax Cut on Pension Contributions Could Shrink Retirement Savings

A former minister has revealed that Chancellor Rachel Reeves may be preparing to execute an unexpected cut to pension contributions in an effort to raise as much as £16 billion annually.

Warning of Potential Pension Cuts Amid £16 Billion National Insurance Proposal

Former MP and minister in David Cameron's coalition government, Sir Steve Webb, warned that the backdoor raid on pension contributions might have an impact on workers' pension pots, reports Express.

He proposed that employers could be required to pay National Insurance on the contributions they make to employee pension pots.

While the former minister argued that the change wouldn't be too challenging for employees, it would impose significant costs on employers and could negatively affect investment, wages, and economic growth.

Many companies currently contribute more than the 3% legal minimum to their employees' pensions. However, if National Insurance is added to these contributions, they may be forced to reduce pension payments.

This would decrease the amount of pension savings that workers can put away for a secure retirement.

Tax relief on pensions costs the government about £49 billion annually, and Chancellor Rachel Reeves is reportedly looking at cutting this amount to help address a supposed £22 billion gap in the budget.

Sir Steve, now a partner at pensions consultancy LCP, suggested that applying National Insurance to employer contributions would be a simpler option compared to alternatives like lowering the tax-free lump sum people can take when they retire or introducing a single flat rate of relief on employee pension contributions.

He explained that, right now, employers don’t pay National Insurance on pension contributions. If they were charged the regular 13.8 percent rate, which they already pay on wages over £175 a week, it could generate around £24 billion.

However, after accounting for the extra costs this would create for public sector employers like the NHS and schools, the actual increase in Treasury funds would be closer to £16 billion.

Government Considering Changes to Pension Tax Relief for Extra Revenue

Both the Institute for Fiscal Studies (IFS) and the Resolution Foundation have suggested this idea as a way for the government to boost revenue. The IFS pointed out that there’s a strong reason for change, as tax relief mainly helps higher earners and those with employers offering more generous pension contributions.

Sir Steve told the Times that this idea might appeal to Rachel Reeves because it could be rolled out quickly and wouldn’t directly affect employees right away.

He added that it could be framed as fixing an unfair advantage some employers get through salary sacrifice, a system where they reduce staff wages but cover their pension contributions to lower their tax burden.

Another option he mentioned for increasing government funds would be to stop pension contributions from being eligible for salary sacrifice altogether.

“The big advantage for the chancellor is that in most cases this [changes to NI] would have no immediate pay-packet effect on voters, so would have lower political saliency. It could also be implemented relatively quickly,” he stated.

Pension tax relief is seen as an essential incentive to help people save for retirement and avoid relying on government support. It costs £70.6 billion overall, but the government gets back £22 billion in income tax from pensioners, leaving a final cost of £48.7 billion, according to calculations by LCP.

LCP stated: “If the government could save even a small percentage of this total cost, it could make a meaningful contribution to the Treasury’s overall tax and spending plans.”