Rachel Reeves’ £5bn Pensions Change ‘Will Leave 3m Worse Off’
Rachel Reeves’ controversial pension tax change is shaping up to be one of the most significant attacks on workplace saving in years, with millions of employees potentially facing higher National Insurance bills from 2029.
The policy is expected to raise almost £5 billion in its first full year. The Treasury says it is a necessary reform to prevent salary-sacrifice arrangements from becoming an increasingly expensive tax break. But critics warn that the measure could discourage people from saving for retirement at precisely the moment Britain is being told that millions are not putting enough aside.
That contradiction deserves far more attention.
Under the reform, announced in the 2025 Budget, employees will continue to receive the existing tax advantages on pension contributions made through salary sacrifice up to £2,000 a year. Above that threshold, however, the amount sacrificed will become subject to employee and employer National Insurance from April 2029. The government expects the measure to raise £4.845 billion in 2029–30 and a further £2.585 billion in 2030–31.
The numbers are enormous.
But so is the potential impact on savers.
The Treasury estimates that around 7.7 million employees currently use salary sacrifice to contribute to workplace pensions. Of those, approximately 3.3 million sacrifice more than £2,000 of salary or bonuses. Those people will be directly affected by the new rules if they maintain their current arrangements.
That is where the headline claim that “3 million will be worse off” comes from.
It is important, however, to understand what “worse off” actually means.
The government is not confiscating pension savings. It is not abolishing pension tax relief. Nor will everyone using salary sacrifice pay more. The first £2,000 remains protected, and the government estimates that around 56% of people currently making typical pension contributions through salary sacrifice will be completely unaffected.
The people most exposed are those making larger contributions.
For them, the amount above £2,000 will attract National Insurance. The Treasury estimates that the average additional employee National Insurance liability will initially be about £84 a year among affected employees.
That may not sound catastrophic.
But pensions are a long-term game.
A seemingly modest annual reduction in pension contributions can become significant when repeated over decades. More importantly, the psychological effect of changing the rules may be just as important as the immediate financial cost.
People need confidence that saving for retirement will continue to be rewarded.
Britain already has a serious retirement-saving problem. The government’s own Pensions Commission warned in May that around 15 million people are currently undersaving for retirement.
Against that background, anything that weakens the incentive to contribute deserves close examination.
The government’s defence is straightforward.
Salary sacrifice is a tax arrangement that allows employees to give up part of their salary in return for an additional employer pension contribution. At present, the arrangement can reduce both employee and employer National Insurance bills. The Treasury argues that the cost of this relief has risen sharply, from £2.8 billion in forgone National Insurance contributions in 2016–17 to £5.8 billion in 2023–24. Without reform, it expects the cost to reach around £8 billion by 2030–31.
From the Treasury’s perspective, that is an increasingly expensive subsidy.
There is also a fairness argument.
Not every worker has access to salary sacrifice. It depends on whether an employer offers the scheme, meaning some employees can benefit from a tax advantage that is unavailable to others. The government says the £2,000 threshold protects typical contributions while reducing what it regards as a disproportionate benefit for higher earners.
But the Institute for Fiscal Studies has raised an important criticism.
It argues that the reform creates another arbitrary dividing line in the tax system and that higher earners, particularly those in the private sector, are more likely to be affected.
That does not necessarily make the policy wrong.
But it shows why the reform is more complicated than a simple battle between “taxing the rich” and “protecting pensioners”.
There is another group to consider: employers.
The new rules will also impose employer National Insurance on salary-sacrifice pension contributions above the £2,000 threshold. That means companies may face additional costs if employees maintain their existing pension contributions.
Employers could respond in several ways.
They could absorb the extra cost. They could reduce the amount they contribute. They could alter their salary packages. Or they could encourage employees to use different pension arrangements.
The outcome will depend heavily on individual employment contracts and workplace schemes.
That uncertainty is itself a problem.
Pensions are supposed to encourage long-term planning. Workers make decisions based on assumptions about their salary, employer contributions, taxation and retirement age. Repeated changes to the rules make that planning harder.
And there is already evidence that uncertainty can influence behaviour.
In a letter to Reeves before the policy was announced, major insurers warned that restricting salary sacrifice could lead people to reduce their pension contributions. Industry research cited by the Association of British Insurers suggested that two in five people could save less if the change went ahead.
That warning should not be dismissed.
The government wants to raise billions of pounds today.
But the purpose of pension policy is to prepare people for tomorrow.
If the reform succeeds in raising revenue while leaving retirement saving unchanged, the Treasury will have achieved its objective. If millions of workers respond by reducing contributions, however, the policy could create a long-term problem that is much harder to solve.
The irony is particularly striking because the government is simultaneously pursuing major pension reforms designed to improve retirement outcomes.
The Pension Schemes Act 2026 aims to improve value for money and investment performance, with the government arguing that stronger pension schemes could significantly improve retirement pots. A new framework will require schemes to publish information about investment performance, costs and service quality, with the reforms being rolled out from 2028 and 2029.
So ministers are effectively pulling in two directions.
On one side, they want people to save more and want pension schemes to produce better returns.
On the other, they are making one important method of pension saving more expensive for millions of workers.
That does not automatically make the policies incompatible. The government could argue that improving investment returns matters more than preserving every existing tax advantage.
But savers are entitled to ask whether they are being encouraged or discouraged.
The answer increasingly appears to be: both.
There is also a political calculation.
Pensions are one of the most sensitive subjects in British politics. Workers may tolerate complicated changes to business taxation or corporation tax, but retirement savings are deeply personal. Someone contributing every month for decades understandably wants to know that the rules will remain reasonably stable.
A government that repeatedly changes those rules risks damaging trust.
That is why Reeves should be judged not simply by how much money this measure raises.
The £4.845 billion forecast for 2029–30 is certainly attractive to a Treasury under pressure. But the government should also measure whether pension contributions fall, whether employers reduce contributions and whether employees switch away from salary sacrifice.
If those effects are significant, the policy’s apparent revenue gain could come with a substantial long-term cost.
None of this means Britain should never reform pension tax relief.
Tax expenditures need to be examined. The system should be fair. And the government cannot ignore the fact that some pension tax advantages have become increasingly expensive.
But reform should be designed around the long-term objective of getting more people to save adequately for retirement.
That is the crucial test.
Britain already has millions of people who are not saving enough. If the new rules encourage even a portion of current savers to contribute less, the government could end up fighting tomorrow’s pension crisis while celebrating today’s tax receipts.
That would be a spectacularly short-term approach.
The claim that Reeves’ £5 billion pension change will “leave 3 million worse off” therefore needs qualification. Around 3.3 million people currently make salary-sacrifice pension contributions above £2,000 and could face additional National Insurance if they maintain those arrangements. But the average additional employee liability is estimated at £84 in the first year, and many people will be unaffected altogether.
The bigger question is what happens next.
Will workers simply accept the extra cost?
Will employers change their pension schemes?
Will contribution rates fall?
Or will the government ultimately discover that making retirement saving more expensive was a false economy?
Those questions will take years to answer.
For now, one thing is clear: Reeves’ pension reform is not the simple tax grab its critics portray, but neither is it a trivial technical adjustment.
It changes the incentives surrounding one of Britain’s most important forms of long-term saving.
And with millions of people already undersaving for retirement, that is a risk the government cannot afford to ignore.
The Treasury may collect billions.
But if the price is a generation of workers with smaller pension pots, Britain could eventually discover that the bill was much larger than the one announced in the Budget.