The Spring Statement on Wednesday brought a dramatic increase in the threshold for national insurance contributions and a small cut to the basic tax rate to 19% as the government is under pressure to show it is supporting people through a cost of living crisis, though experts say median earners will still be worse off. There were no big pension announcements, but how might tax changes interact with pensions?

 

On Wednesday, chancellor Rishi Sunak brought the amount earned that is free from national insurance contributions in full alignment with the income tax threshold. It was due to go up slightly but he chose to bring them into line now in a bid to prove that the government is supporting people during a period that has seen the highest inflation in 30 years. 

 

From July, for this tax year, those earning below £12,570 will not have to pay NICs; previously, the threshold stood at £9,880. The Treasury says the change means 70% of those who currently pay NICs will pay less than they currently do, even after accounting for the introduction of the Health and Social Care Levy. 

 

The controversial levy of 1.25% for employers and employees is intended to initially provide extra funding for the NHS, before potentially being used to fund social care. The chancellor chose to stick with the levy during the crisis, which is in practice equivalent to national insurance.  

 

Those over state pension age already do not pay NICs; the Treasury now says that raising the NICs threshold means 2.2m people will be taken out of paying NICs and the Health and Social Care Levy entirely, on top of 6.1m workers who already do not have to pay NICs. 

 

 

How are Wednesday’s announcements financed? “The cuts to income tax and National Insurance are effectively paid for by increasing revenues as a result of fiscal drag,” said Paul Johnson, director of the Institute of Fiscal Studies. In March last year, the government said it is freezing income tax thresholds until 2026. This is now set to have a huge impact because of the rise in expected inflation over that period. 

 

The freezing of the income tax personal allowance and higher rate threshold turn out to be much bigger tax rises than first intended, said Johnson. “As a result, almost all workers will be paying more tax on their earnings in 2025 than they would have been paying without this parliament’s reforms to income tax and NICs, despite the tax cutting measures announced today,” he said. “If he wants to be remembered as a tax reforming chancellor, so far he is headed in the wrong direction.” 

 

The IFS has calculated that by 2025-26 “virtually all workers will be paying more tax on their earnings than they would have paid without these changes to rates and thresholds”. Bringing together expected changes in earnings, reforms to taxes, and the energy measures announced in February, a median earner on £27,500 per year can expect to be about £360 worse off this year than they were last year, according to the IFS. 

 

 

Lifting the NICs threshold will not affect state pensions, explained Steve Webb, partner at LCP and a former pensions minister. "You get NI credits as soon as you earn over the ‘lower earnings limit’,” he said, which is just over £6,000, whereas the chancellor has only changed the point at which NICs are actually paid. 

 

The reduction in the national insurance threshold means there is a growing discrepancy between the auto-enrolment trigger and both tax and NICs, potentially meaning that for those earning between £10,000 and £12,570, pension deductions are noticed more on payslips. While inflation is still rising – currently at 6.2% and expected to go higher this year – could this tempt more people to opt out? 

 

Tim Smith, a professional support consultant at law firm Herbert Smith Freehills, said the challenges people are facing from the increase in the cost of living will put pressure on their appetite and ability to contribute to their pensions.  

 

“While the measures announced by the chancellor today offer some help, they do not offset the dramatic increase in prices that people are experiencing. Auto-enrolment has withstood a number of tests so far, but the next couple of years are likely to pose a significant test of its resilience,” he cautioned. 

 
People earning between the two thresholds will not be the norm, said David Robbins, a senior consultant at WTW, but for those who do, "it may make the value of the deduction a little more stark". The actual fall in real take-home pay will be a more material factor than this, he added, but "inertia remains a powerful force and taking money off your future self remains a hard thing to do, especially when this involves handing back employer contributions".

 

As well as lowering the NICs threshold, the government is reducing the basic rate of income tax to 19% from 20% in 2024. The Treasury said more than 30m will pay less tax in 2024-25. Pensioners will benefit from the change too as they pay income tax but not national insurance contributions.

 

But changing income tax rates always also affects tax reliefs. While the government is introducing a phase-in for gift aid to help charities, there is no similar plan for pensions.  

"The change may be grist to the mill of those advocating flat rate relief, but it doesn’t take away the difficulties with introducing such a system," said Robbins. Once tax relief rates are different from a person’s marginal tax rate, a way needs to be found to tax employer contributions – including employer-financed defined benefit accrual – as a benefit in kind. 

"The government would effectively be [taxing] the same income twice and topping it up in between and could vary the top-up at the flick of a switch, making it hard for people to know whether the current tax year was a good time to save," he observed.

A reference in the chancellor's tax plan to reviewing tax reliefs is not revealing whether pensions tax relief could be in scope.

Mainly however, the change in the basic tax rate "makes a mess of some of the communications used around automatic enrolment, which suggest that, for a basic rate taxpayer the 5% default employee contribution includes 1% in tax relief", said Robbins.

In the end, it might not all be bad, however, he said, as tax is often due on the way out. "Equating upfront tax relief with the value of government support for pension saving can often overstate the value of the fiscal incentive," he said.

 

Kate Smith, head of pension at provider Aegon, said the good news of the tax reductions comes with “a pensions fly in the ointment”. A reduction in the basic rate of income tax means that people will get lower tax relief on their pension contribution. “The government top-up directly into their pensions will be less. This means that to get the same retirement income, people will have to pay a little bit more into their pensions,” she said, suggesting people might want to think about putting more into their pensions before the change comes into effect in 2024. 

 

In its tax plan, the government has also pointed out that there are more than 1,000 tax reliefs and allowances in the tax system. "They play an important role but can also be costly and complex,” the plan reads. “We have already reformed some reliefs and allowances and will look to go further ahead of 2024.” This has prompted renewed speculation about pensions tax relief, although there has so far been little appetite in the Treasury to make a change that would mainly affect ‘middle Britain’, including core Conservative voters, as the 2024 election nears.

Fears have also been raised over the Office for Budget Responsibility revising its forecast for tax take from over-55s drawing on pensions to £1.7bn, up on £400m in 2020-21 and the £500m forecast in October. 

“If over-55s are increasingly accessing pension funds to meet an immediate shortfall in income, this is likely to have a detrimental effect on their living standards in later life. The take-up of guidance or advice is essential in helping people understand the impacts down the line of decisions that are made now," warned Renny Biggins, head of retirement at The Investing and Saving Alliance.
 

Kate Smith

Tim Smith

Ian Neale

Gareth Stears

 

Tim Gosling