Budget impact on independent schools exceeds expectations

Independent Schools were braced for the worst going into the Budget but if anything, the impact was worse than expected.  

A surprising National Insurance (NI) hike

The introduction of VAT on fees and removal of business rate relief was expected (they come on top of an increase to the costs of the Teachers’ Pension Scheme earlier this year) but the big surprise was National Insurance (NI). Labour’s commitment to shield employee taxes meant an increased employer NI burden, but staff are still likely to feel the effects indirectly. 

The 1.2% increase in NI is arguably a little larger than expected, but the lowering of the secondary threshold is what will really hit home for many schools. 

The real-life impact on schools

For an individual earning £35,000 (broadly UK average) the increased school NI cost is £925.80, but £615 of this comes from the threshold change. Schools with highly paid staff members will see a larger increase in National Insurance costs in absolute terms. However, in relative terms, schools with lower-paid employees will experience a greater percentage increase in NI costs — a category that includes many school staff. 

Whilst the budget increase in minimum wage can be seen as a positive, if someone goes from an annual equivalent (37.5 hours p/w) of £20,319 to £21,680, not only does that cost the school an additional £1,361.37 in salary, but now also an additional £920.42 in NI - that’s £2,281.79 or 11.23%.

What can schools do? 

In essence, not a lot – this measure has been designed to raise revenue and it will do. 

Salary sacrifice as a tool

Reducing salary will be effective, with salary sacrifice in particular likely to be considered by more schools now that we know it will continually be available (for the time being). That said, this won’t help people close to minimum wage, as schools shouldn’t be using this where it would take people below that level. Even for earners above minimum wage, the initial £615 will generally be protected, but salary sacrifice will at least save 14.8-15% on whatever amount is being sacrificed, whether for pensions, electric car schemes etc.  

If there’s any positive news here, it’s that the high pension contribution required by the Teachers’ Pension Scheme (TPS) will still remain exempt from NI, although salary sacrifice can’t be used for this scheme. It feels this will be scant consolation though. 

Outside of this, the options will be:  

• absorb the cost 
• increase fees; or  
• reduce spend.  

The latter is likely to be in part through reduced pay in the future, and many schools may have already used this mechanism to absorb some of the TPS increase. 

As an example, schools that budgeted to award a 3% pay increase next year would need to reduce these increases to the following to mitigate the increases in costs (ignoring pension contributions and other salary-related employee benefits). 

• 0.67% (£35k salary) 

• 1.19% (£60k salary) 

• 1.49% (£100k salary) 

Whilst schools might not go the whole way, or even things out across earnings bands, it feels inevitable that this will suppress pay increases. 

Recalculation of cash allowances

Another consideration connected to this is that any ‘cash allowance’ that schools offered in relation to alternative pension schemes might need to be recalculated, if it considers a school’s NI liability.For example, before a school might offer, say, 10% of salary to be taken as a cash allowance. This would be 8.79% after the old 13.8% NI rate, but 8.70% on the new rate from April. Schools should consider whether to adjust this mechanism carefully and check how it was communicated to staff. 

Implications of death benefits being subject to Inheritance Tax (IHT)

Although it doesn’t impact schools directly, the other big pensions news was death benefits becoming subject to IHT. It’s interesting that scheme pensions (as opposed to annuities) seem set to get preferential treatment being taxed at the recipient’s marginal rate, and TPS is likely to fall within this.   

Where defined contribution (DC) pensions are offered it is worth explaining this difference. IHT change, like NI, was heavily trailed, and perhaps is understandable given that pensions being used as an estate planning tool was very much a by-product of the 2015 Freedom and Choice legislation. What it does create is complexity and confusion for people who have been using DC pensions with that in mind.  

With an introduction date of 2027 there is at least time to iron out the details, but if people are looking to take money out of pensions and make lifetime gifts, the clock will always be ticking due to the seven-year gift disposal timeframe. Of course, pension income is generally taxed anyway (outside of the tax-free lump sum) so there is the potential for double taxation if people aren’t careful – someone who draws their pension fund in one go could be taxed at 45% only to see the proceeds go into their estate for IHT purposes. Pensions are still a tax-advantaged framework in terms of growth of the fund, so any decisions should be considered carefully and advice taken. 

Affected by these issues?

Our experts are on hand to help school business teams and governors analyse business performance and navigate the risks. Learn more about our Data Navigator tool, the interactive dashboard developed for independent schools looking to benchmark their data, or find out how our education consultancy can help you.