Chancellor Reeves is planning to reduce tax relief on pension contributions

In her capacity as Chancellor of the Exchequer, Rachel Reeves is reportedly targeting employee pension contributions as part of her effort to raise additional funds for the Budget.

Reeves is expected to target pension contribution tax perks in the Budget, limiting reliefs for both employers and employees to help boost Treasury revenues by £2 billion ($2.6 billion) per year.

However, there are concerns that the policy will unfairly penalise those who responsibly save for retirement and could also harm company pension plans.

Reeves will not limit tax-free pension lump sum withdrawals 

Reeves had told the Office for Budget Responsibility she intends to hike income tax when she delivers the Budget on 26 November. According to reports, Reeves is contemplating a 2p income tax alongside a 2p national insurance cut, breaking from Labour’s manifesto commitment.

Insiders say Reeves has opted against reducing tax-free pension lump sum withdrawals amid concerns that it would hurt pensioners. Retirees will still be able to take up to 25% of their pension—capped at £268,275—tax-free. However, she is turning her attention to salary sacrifice schemes in an effort to address the £30 billion funding gap.

This week, the deputy Labour leader, Lucy Powell, warned that if the Chancellor breaks the party’s income tax pledge, it could undermine voters’ confidence. However, some economists argue that the combination of policy reversals, increased debt, and slow economic growth leaves Reeves little choice but to raise taxes or abandon her flagship borrowing targets.

So far, officials see trimming pension tax reliefs as one of the easiest ways to boost revenue. Salary sacrifice currently allows workers to funnel any amount into their pensions before national insurance is charged, with contributions taken from pay before tax is deducted.

Reeves is expected to limit this to £2,000 a year in the upcoming Budget. Any pension contributions exceeding £2,000 ($2681) would incur national insurance at 8% on salaries below £50,000 (approximately $ 65,795) and 2% on income above that threshold. Workers who use salary sacrifice to invest more than £2,000 in their pensions will feel the impact, even though 15% of their salary is suggested for retirement savings.

For a basic-rate earner on £50,270, saving 6% of pay would increase national insurance by £80 annually, while saving £5,000 (10%) would add £240 ($315). Experts caution that many workers would face a double blow, since employers would also forfeit tax relief on pension contributions. Currently, employers receive full relief from the 15% national insurance on salary-sacrifice pension contributions. Reeves plans to limit this, which would increase the cost for a £50,270 employee saving 10% of pay by £450 ($592) a year.

Companies may reduce their pension benefits to employees

Steve Webb, a partner at pension consultants LCP, is opposed to tightening tax relief. He commented: “Salary sacrifice schemes have been around for a long time and are a way of encouraging employers to offer good workplace pensions. Introducing a cap would increase national insurance bills, mostly for employers and hit the very firms who are doing the right thing.”

He cautioned that a cap could create fears that pension benefits are on the chopping block, potentially paving the way for eventual removal of pension perks, at a time when greater pension engagement is necessary.

The Society of Pension Professionals’ tax group chair, Steve Hitchiner, said that the changes would likely push firms to make their pension schemes less generous to offset higher taxes.

He explained that the reform would make salary sacrifice pensions more expensive for employers, due to the 15% national insurance payable on employee contributions. Similar to Webb, he also noted that employers may pass the additional expense to staff in the form of lower pension contributions or smaller raises.

Some businesses have also given their opinions on the matter. One company said it would be left explaining to staff why their payslips will vary despite their previous stable earnings, while another accused the government of attempting to raise money “through the back door.” Some firms even suggested that, if the impact is significant, they may end their salary sacrifice programs.

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