Flat rate pension tax relief could mean the end of salary sacrifice, says expert

Out-Law Analysis | 23 Feb 2016 | 10:32 am | 1 min. read

FOCUS: With the smart money on the UK government introducing flat rate tax relief on pension contributions in the Budget, employers should be prepared to make radical changes to salary sacrifice schemes.

Depending on what is announced next month, employers may be required to change or disband existing arrangements - which, in turn, will require complex communication exercises with affected employees. Employers need to take stock of any arrangements currently in place so that they can act quickly, if necessary, and should avoid planning major projects for the second half of March that may use resources needed for urgent pensions changes.

Employers currently putting new salary sacrifice arrangements in place or considering new schemes can still press ahead, but they need to be aware that schemes could have a short shelf-life.

Flat-rate tax relief and salary sacrifice

Salary sacrifice arrangements allow employers and employees to mutually agree changes to the terms of the employee's employment contract, reducing that employee's entitlement to cash pay in return for some other form of benefit. This can be financially beneficial for both parties, as certain benefits are wholly or partially exempt from income tax and employer and employee National Insurance Contributions (NICs).

These schemes do not sit easily with flat-rate tax relief on pension saving. An employee whose marginal rate of income tax is above whatever the flat rate is could, by saving to a pension through salary sacrifice, ensure that his or her contributions are treated as employer contributions – in which case, the employee would not be taxed on the contributions paid. The Treasury and HM Revenue and Customs would therefore have to plug this loophole by ensuring that employer contributions are taxed as if paid by employees.

This tax treatment could also extend to NICs and would present some technical difficulties, especially in relation to defined benefit (DB) schemes where benefits are guaranteed by the employer. In this scenario, salary sacrifice for pension savings would no longer offer any tax sadvantages.

Salary sacrifice under threat

Whether this is what the government has in mind is unclear - although it is already evident that the government is concerned about the growth in the use of salary sacrifice arrangements. The Autumn Statement confirmed that the government was gathering "further evidence" on salary sacrifice arrangements to "inform its approach"; and one Conservative MP has recently gone public with a call for a £10,000 salary sacrifice cap. That MP, Craig Mackinlay, is also a member of the House of Commons work and pensions committee.

The UK government is also due to respond to its consultation on the 'green paper' on pension tax, which was published alongside the Summer Budget and proposed even more radical changes to pension tax relief.

Carolyn Saunders is a pensions expert at Pinsent Masons, the law firm behind Out-Law.com.