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During the recent Budget announcement, chancellor Rachel Reeves revealed significant changes to salary sacrifice pension schemes. Starting in April 2029, the maximum amount workers can contribute while still receiving the same tax relief will be limited to £2,000.
But what exactly is salary sacrifice and how will these changes impact those who currently utilize these schemes? FT Money delves into the details:
What is salary sacrifice?
Salary sacrifice schemes enable employees to exchange a portion of their salary for increased pension contributions.
This results in reduced tax liabilities for both the employee and employer, as neither party is required to pay national insurance on the pension contributions. Employers face a 15% national insurance rate, while employees are subject to an 8% rate for earnings below £50,270 and a 2% rate for higher incomes.
Who uses them?
Government statistics show that nearly 8 million people in the UK utilize salary sacrifice schemes.
While these schemes are prevalent in the private sector, they are less common in the public sector where employer pension contributions tend to be higher.
A vast majority of large companies offer salary sacrifice schemes, with over 90% of employees participating, according to a survey by Willis Towers Watson.
How are the rules changing?
Beginning in the 2029-30 tax year, individuals will only be able to contribute up to £2,000 into a salary sacrifice scheme while receiving national insurance relief. Any contributions exceeding this limit will be subject to standard national insurance rates.
Employees opting for salary sacrifice to receive tax-free childcare can continue to do so, but contributions above £2,000 will not receive national insurance relief.
The government anticipates generating £4.7 billion in revenue in the first year of implementation, with a decrease to £2.6 billion the following year. The initial surge in revenue is attributed to some individuals transitioning to relief-at-source pension schemes, where income tax is paid upfront at the marginal rate.
How much will it cost me?
The government estimates that 75% of basic rate taxpayers will remain unaffected, as their contributions are below the £2,000 threshold.
For example, an individual earning £50,000 and sacrificing 5% of their salary would incur an additional £40 in employee national insurance and £75 in employer national insurance for contributions exceeding the £2,000 limit.
On the other hand, someone earning £100,000 and contributing £12,000 to their pension through salary sacrifice would face costs of £200 for the employee and £1,500 for the employer.
How might my company respond?
While the changes pose greater financial implications for companies, employees are likely to feel the impact as well.
The Office for Budget Responsibility predicts that employers will shift approximately 75% of the added costs to employees, with reductions in pension contributions and salaries/bonuses.
Companies have over three years to strategize their response, which could involve adjusting wage growth and increasing employer pension contributions to mirror the benefits of salary sacrifice. However, implementing such changes on a company-wide scale may prove challenging.
Louise Jenkins from Alvarez & Marsal suggests that the response from companies will vary based on their workforce composition, highlighting that the scheme may remain attractive for companies with lower-paid employees not exceeding the £2,000 threshold or facing an 8% national insurance rate.
Some employers may opt to discontinue salary sacrifice altogether due to the perceived complexity of administering the £2,000 threshold from a payroll standpoint.