Salary sacrifice – is change on the horizon?

In the run up to last year’s Autumn Budget there was considerable speculation over the tax breaks afforded to pension contributions and lump sum payments. Also in the spotlight was the extent to which national insurance (NI) exemptions were applied to employer pension contributions.

In the end, the only change announced was in relation to Inheritance Tax (IH) and the future inclusion of unused pension funds in the deceased’s estate for calculating IHT.

So, it was interesting to see HMRC’s recent publication of research into employer’s attitudes towards salary sacrifice arrangements for pension provision and analysis on how these perceptions change under hypothetical changes to the tax treatment of these arrangements. Using salary to fund pension contributions is a well-established practice. In 2019, the ONS reported that 30% of employees in the private sector and 9% in the public sector funded contributions in this way. These arrangements involve an employee voluntarily surrendering part of their earnings (which would normally be subject to income tax and national insurance) in exchange for a non-cash benefit, in this case an employer pension contribution, which is exempt from income tax and also employer and employee national insurance contributions. This arrangement works well for employers who avoid paying the 15% NI rate applicable for earnings above the secondary threshold.  Many employers also use part of their NI savings to top up pension contributions paid by the member. Even without a top-up from the employer, member contributions paid under salary sacrifice are uniquely privileged as contributions under both the net pay arrangement and relief at source, are included as earnings when calculating NI contributions. With salary sacrifice arrangements, the employee does not pay NI on the amount sacrificed. In addition, higher or additional rate tax relief is obtained immediately, with no need to reclaim tax through self-assessment (as would be the case for contributions under relief at source).

Of course, the recent increase in employers NI contributions make salary sacrifice arrangements look even more attractive and reports show significant increases in interest from employers who are looking at this as a way of protecting their bottom line.

HMRC’s report finds that employers currently offering salary sacrifice arrangements demonstrate overwhelmingly positive attitudes toward these schemes. The research found that employers view salary sacrifice as an integral component of their overall employee benefits package, with many citing its contribution to employee retention and recruitment efforts. These arrangements are perceived as providing tangible value to both employers and employees through the dual benefit of NI savings and enhanced pension contributions.

The report also analysed employer reactions to the removal of the NI exemption under three different scenarios. In scenario one, employer contributions arising through salary sacrifice would be subject to NI contributions (employer and employee). Scenario two involved the removal of both NI relief and income tax relief on contributions. Scenario three sought to find some middle ground, using the threshold- based approach that would place a cap on the current benefits of using salary sacrifice.

Naturally, the most negative response arose for scenario two. Given the widespread availability of relief at source, removing both the NI and income tax exemption for salary sacrifice contributions would make these arrangements inappropriate for funding pensions. The continued use of funding pensions under salary sacrifice without tax relief would be clearly detrimental to members and employers would reconsider the use of salary sacrifice arrangements under these conditions.

Scenario three received the most favourable feedback with employers. With this approach the current benefits of the existing system would continue to apply, albeit with restrictions. Whilst this received the most favourable feedback, practical considerations detailing how this restriction would apply, were lacking. Any perceived increase in the administration of salary sacrifice schemes would only act as a disincentive to offering them – even under the current system, the administration of these schemes is one of the main barriers to setting them up, for smaller and medium sized companies.

Both scenarios two and three seem almost designed as framing exercises for scenario one. Arguably the unique benefits for employees wishing to fund their pension using salary sacrifice seem overly generous when compared to the alternative methods of member contributions and this provides a logical rationale for change that can be justified as levelling the playing field. A similar justification was used when announcing the proposals to subject pension funds to IHT, although here the levelling down was in relation to the IHT position between schemes that paid either ‘discretionary’ or ‘non-discretionary death benefits. If in the Autumn the government needs to raise additional taxes whilst not changing the headline rates for personal taxation, removing the NI exemption for salary sacrifice contributions does seem an easy target.

All information is based on our understanding and interpretation of applicable law and regulation.

 

 

1. Introduction
2. Transact Online (TOL) –  Recent enhancements 
3. Integrations – mini-events
4. Trusts – the new business process
5. Overseas fund regime
6. Successions planning update – employee ownership trusts
7. Transact – BlackRock MPS update from Ben Roberts (MPS Manager)
8. A study in gifting – too late to change after death?
9. Investment bonds – topping up verses new policy
10. Salary sacrifice – is change on the horizon?
11. Interest on cash
12. Transact events 2025