New analysis suggests the government’s proposed £2,000 cap on National Insurance relief on pension contributions could disproportionately affect middle-income workers, despite being designed as a measure for high earners.
According to research by Bishop Fleming, the structure of Britain’s national insurance system creates a so-called “middle income trap” where workers earning between £35,000 and £50,270 face significantly higher effective tax rates on pension contributions above the cap than those on much higher salaries.
Tax experts at the company point out that workers in this middle income group would have to pay a National Insurance levy of 8% on contributions above £2,000, compared to just 2% for those earning more than £125,000. The result, they argue, is that mid-level jobs like nurses, teachers and managers could face far higher penalties for extra retirement savings than top earners.
The analysis also points to broader implications for salary sacrifice programs, which have long been used by employers to increase pension contributions by sharing their Social Security savings with employees.
Under the proposed changes, employers would have to pay a 15 percent social security levy on contributions above the cap, significantly reducing the financial incentive to offer these “top-up” contributions. Industry experts warn that many companies may reduce or abandon these benefits.
In combination with the employee levy, this leads to a so-called “efficiency cliff of 23 percent” for the affected employees, which practically negates the benefits of higher pension savings through salary losses.
While the government has indicated that the majority of workers will not be affected because their contributions fall below the £2,000 threshold, analysis suggests the impact could be more widespread.
Data from the Office for Budget Responsibility suggests that a significant portion of the additional costs employers face are likely to be passed on to workers through slower wage growth or reduced benefits. This means that even those below the cap could feel the impact indirectly through smaller wage increases or the loss of pension improvements.
The proposed changes are also expected to increase cost pressures for businesses, particularly small and medium-sized businesses.
Businesses are already bracing for broader employment reforms and rising labor costs, and the introduction of additional pension levies could force difficult decisions around pay, hiring and benefits.
For some employers, the decision may come down to reducing pension contributions or limiting wage increases to offset the additional costs.
Experts warn that weaker incentives to save for retirement could have longer-term consequences for retirement prospects, particularly for middle-income workers who are already under pressure from rising living costs.
By reducing the attractiveness of salary sacrifice schemes and increasing the cost of saving, the reforms risk discouraging contributions at a time when policymakers have encouraged individuals to build greater financial resilience for retirement.
The proposed Social Security cap is likely to remain a point of contention as details are discussed and refined.
While the policy aims to reorient tax breaks and generate additional revenue, critics argue that its design could have unintended consequences by shifting the burden onto middle earners and reducing incentives to save.
As businesses and employees begin to assess the potential impact, the focus will turn to whether adjustments will be made to address these concerns, or whether the changes will continue in their current form and have a widespread impact on the UK pensions landscape.
