How employees over 55 could pay substantially less tax

25 April 2023
HMRC and the Office of National Statistics (ONS) have published their latest estimates of how many individuals are in paid employment. The figures paint a challenging picture for the year to date.

In his Budget speech, the chancellor highlighted that, excluding students, there were over seven million adults of working age who were not in work. The latest statistics show the problem is potentially getting worse as the numbers of individuals in payrolled employment are going backwards. At the turn of the year, it is estimated that there were 29,962,404 in payrolled employment and this has decreased by just under 90,000 at the end of March 2023.

In the calendar year to date, only those aged 65 and over have seen significant increases in the numbers in payrolled employment. Whilst other age groups’ figures broadly flatline or go backwards, there has been over a 2% increase in workers aged 65 or over since the turn of the year. That continues a trend and this age group has been the fastest-growing since the beginning of 2020, with nearly 19% growth.

Perhaps this should not be a surprise as many older workers have a lower effective tax rate than others on their earnings. Those over the state pension age do not suffer employee’s national insurance contributions (NIC), representing an effective tax cut of 12% on earnings over £12,570.

A key strand of the chancellor’s plan at the Budget was to incentivise those over the age of 50 back into work. Following the changes made to pensions in the Budget, many of those over 55 encouraged back into work could pay very little overall income tax on part-time earnings of, say, £20,000 per year. In particular, an increase in the money purchase annual allowance permits those who have already flexibly accessed their pension benefits to contribute £10,000 a year from 6 April 2023, rather than the previous limit of £4,000.

Some employers offer a salary sacrifice scheme in relation to pension contributions. This allows for some of an employee’s gross pay to be contributed to a pension pot. Depending on the amounts, this contribution may be free from income tax and both employers’ and employees’ NIC. Due to the savings on NIC for the employer, some employers offer to match or top up the pension contributed by the employee. 

If we take the example of an employee aged over 55 earning £20,000 not currently making any pension contributions, they would have net take-home pay of £17,622.

Let’s compare that to a similar worker benefitting from a pension salary sacrifice scheme and assume that the employer is willing to top up an employee’s pension pot by the employer’s NIC saved as a result of this arrangement. Such a worker could sacrifice £8,787 of salary and benefit from an employer pension top-up of £1,213. 

The employee would therefore have £11,213 of taxable salary remaining and £10,000 sat in their pension pot. The remaining salary would be free from any income tax and NIC as it falls within the personal allowance. However, as the individual is aged 55 or over, they could potentially access the funds paid into their pension as well. There are various options for accessing pension funds, but one is to take a payment as an uncrystallised funds pension lump sum (UFPLS). 

An employee accessing £10,000 of their pension pot in this way would receive 25% of this tax free if within the relevant limits. The end result is that the net take-home pay of the individual may be as high as £19,984, giving an effective tax rate of 0.08% on their original £20,000 salary.

There are a number of related points to be aware of. For example, employers should be aware that they could inadvertently breach national living wage limits if they allow employees to sacrifice too much of their salary as pension contributions. In addition, once an individual starts to access their pension, tax relief can only be claimed on £10,000 per annum of any further contributions. Subject to working through the detail, such savings could be attractive to over-55s looking to get back into the workforce.