On 7 September 2021, the Government confirmed that there will be a Budget on 27 October. It also unveiled a package of tax and spending measures that could easily be bigger than anything to be announced in that Budget:
Salary that an employee contributes to a pension is subject to both employer and employee NICs, but employer pension contributions are not NIC-able. The immediate consequence of either raising NICs or supplementing them with a new levy is to make it more attractive for employees to exchange NIC-able salary for NIC-free pension contributions, especially salary that was destined for their pension pot anyway. It will also increase the savings generated by salary sacrifice arrangements.
The Government’s policy paper says: “existing NIC reliefs to support employers will apply to the levy”. From the context, this statement refers to other NIC reliefs, but the expectation must be that employer pension contributions will be exempt from the Health and Social Care Levy: withholding relief from the top-up charge while retaining it more generally would involve all of the complexity of ending NICs relief for a fraction of the revenue.
The tables illustrate the increased gains from this exchange where an employee would otherwise pay a 5% pension contribution that is matched by the employer.
For both current NIC rates and the higher rates applying from April 2022, they show how shifting the design to a 10% employer contribution on the same reference salary can increase the employee’s take-home pay and the amount going into their pension pot, whilst also reducing the employer’s costs. In this example the employer passes half of their NICs (or NICs plus a Health and Social Care Levy) saving to the employee in the form of a higher pension contribution.
Table 1: £30K reference salary, 5% + 5% pension contribution
| Current NIC rates | With extra 1.25% on employer and employee NICs | ||||||
|---|---|---|---|---|---|---|---|
| No salary sacrifice | With salary sacrifice | Difference | No salary sacrifice | With salary sacrifice | Difference | ||
| Take-home pay | £22,862.16 | £23,042.16 | £180.00 | £22,606.76 | £22,805.51 | £198.75 | |
| Total pension contribution | £3,000.00 | £3,103.50 | £103.50 | £3,000.00 | £3,112.88 | £112.88 | |
| Total cost to employer (salary + employer NIC + pension contribution) |
£34,420.08 | £34,316.58 | -£103.50 | £34,684.58 | £34,571.71 | -£112.88 | |
Table 2: £60K reference salary, 5% + 5% pension contribution
| Current NIC rates | With extra 1.25% on employer and employee NICs | ||||||
|---|---|---|---|---|---|---|---|
| No salary sacrifice | With salary sacrifice | Difference | No salary sacrifice | With salary sacrifice | Difference | ||
| Take-home pay | £41,689.16 | £41,749.16 | £60.00 | £41,058.76 | £41,156.26 | £97.50 | |
| Total pension contribution | £6,000.00 | £6,207.00 | £207.00 | £6,000.00 | £6,222.75 | £222.75 | |
| Total cost to employer (salary + employer NIC + pension contribution) |
£70,060.08 | £69,853.08 | -£207.00 | £70,699.58 | £70,473.83 | -£225.75 | |
Calculations use 2020-21 National Insurance Thresholds and the income tax system that applies in England, Wales and Northern Ireland; the total cost to the employer assumes that the employer’s NICs bill is not reduced by Employment Allowance (which benefits smaller employers) and that the employee is not under 21, an apprentice under 25, or a military veteran.
75% of the retirement income associated with the extra pension contribution will be subject to tax, so the net gain to the employee will be smaller than this. For example, if the basic rate taxpayer whose pension contribution rises by £112.88 pays 20% tax on 75% of the associated withdrawal, this extra contribution is worth £95.95 after tax.
NICs are not chargeable on pension income, so NI relief is an end-to-end incentive/subsidy for pension saving. This is different from upfront income tax relief on pension contributions, whose principal effect is to defer when income is assessed for tax; albeit with 25% tax-free in retirement.
Higher rates of NICs, including the Health and Social Care Levy, may put more focus on the cost of this relief. HMRC estimates that NICs relief cost £16.5 billion n in 2017-18. If future Governments find it easier to increase a tax with “health” in its name than other taxes, the cost of NICs relief will escalate.
In practice, though, this official estimate overstates the potential gains to the Exchequer. As is happening with the Health and Social Care Levy itself, a Government abolishing NICs relief would need to compensate public sector employers in order to ensure that a requirement to return more money to the Exchequer through NICs/the Levy does not amount to an indirect cut to their budgets.
Nor is National Insurance relief something the Chancellor can just switch off. Practical considerations include how to value defined benefit pension accrual when calculating the NICs due, and whether the value of employer contributions should push individuals from one NICs band to another.
These questions mirror those that would have to be answered before the Government could stop offering income tax relief on pension contributions at the individual’s marginal rate. NICs relief may therefore be more likely to change as part of a broader shake-up (such as moving to a regime where pension contributions come from post-tax income and are topped up by the Government) than as a stand-alone measure.
Another reason why NICs relief may not be changed in isolation is that, whereas the headline rates of income tax relief are more valuable for higher rate taxpayers than basic rate taxpayers (40% vs 20%), the reverse is true for NI relief – employee NICs are only 2% above the Upper Earnings Limit (currently £50,270) compared with 12% below this level.
The Government’s 2017 Review of automatic enrolment recommended abolishing the lower end of the qualifying earnings band (currently £6,240), so that the 8% statutory minimum combined employer and employee contribution rate applies to earnings from the first pound. The Government talked about implementing this from the “mid-2020s”, while also lowering the minimum age for automatic enrolment from 22 to 18. However, these commitments were absent from the 2019 Conservative manifesto and are excluded from fiscal forecasts on the grounds that they are only “policy ambitions”.
All else being equal, higher deductions from take-home pay through the Health and Social Care Levy seem likely to push back the date on which the Government will allow higher default pension contributions to make a further dent in employees’ disposable incomes.
For an employee earning £30,000 and paying statutory minimum pension contributions, the effect on take-home pay of calculating contributions from the first pound (around £250) is very similar to the effect of the employee Health and Social Care Levy (£255). Moreover, the 1.25% levy on employers and higher minimum employer pension contributions can both be expected to act as a brake on pay growth.
The same considerations will apply to any suggestion that the default pension contribution rates should themselves increase.
Under legislation, the BSP and NSP must rise at least in line with average earnings. The prices and 2.5% components of the Triple Lock are discretionary.
A provisional estimate of the relevant earnings growth number is due to be published on 14 September and should be at least 8%. This high year-on-year increase reflects the extra hours worked as the economy reopened, including when furloughed staff returned to work. Average pay has further increased because job losses during the pandemic were disproportionately concentrated amongst the lowest paid (if the lowest paid person leaves, average pay goes up without anyone having received a pay rise).
The Office for National Statistics has attempted to strip out these effects, but has published a range (3.5% to 4.9%, for a slightly earlier period) rather than a point estimate and warned that these numbers should be “treated with caution”. This analysis also relates to a different measure of earnings than that used for the Triple Lock. With no uncontroversial “true earnings growth” number to use, and with some political flack likely whatever change had been made, the Government perhaps figured that it may as well bank a bigger saving by dropping the earnings component altogether for the April 2022 uprating.
To this end, the Social Security (Up-rating of Benefits) Bill replaces the requirement for pensions to rise at least in line with earnings with a requirement for them to rise by the higher of price inflation and 2.5%; this change to statute would apply to the April 2022 uprating only. Therese Coffey, the Secretary of State for Work and Pensions, told the House of Commons that inflation in the 12 months to September is expected to be the higher number (which implies that the price level will increase by at least 0.5% between July and September).
The BSP is likely to rise from its current level of £137.60/week to a little over £141/week (with the precise number depending on inflation figures due to be published in October). This increase – expected to be around £7 smaller than if the Triple Lock had been applied – will affect defined benefit schemes where a BSP offset applies to the scheme pension. The full NSP should rise from £179.60 to a little over £184.
According to the Office for Budget Responsibility: “The triple lock raises spending by £0.9 billion for every 1 percentage point, and our March forecast assumed uprating of 4.6% next year. So, if earnings growth in the three months to July period that determines triple lock uprating for next April was 8%, as some expect, that would add around £3 billion a year to spending.”
The announcement is therefore the difference between spending roughly £3 billion more than forecast and spending roughly £2 billion less than forecast. Lower tax receipts (because pensioners’ incomes are smaller) will reduce the net saving to the Exchequer but this also means that every future pension increase will be applied to a lower starting amount. Annual savings should therefore grow over time, even if the policy really is for one year only.
Dr Coffey reaffirmed the Government’s commitment to the Triple Lock for the remainder of this Parliament (potentially another three uprating announcements). The more interesting question for those pondering how much they need to save for retirement is what happens after that. This is yet to be confronted.
In theory, it is young people, rather than current pensioners, who benefit most from the Triple Lock – as well as increasing pensions in payment, it effectively revalues those yet to be claimed, and these increases compound over a longer period. In practice, public debt traceable to spending on today’s pensioners and the anticipated level of future pensions could both affect the likelihood of future cutbacks (for example, through a higher age of entitlement).
