Employers reset pension strategy after Royal Assent for salary sacrifice reforms

Employers are reassessing pension salary sacrifice after Rachel Reeves’ far-reaching Autumn Budget changes to National Insurance relief formally became law. The legislation, which received Royal Assent just a few days ago, will from April 2029 limit the National Insurance exemption on pension salary sacrifice contributions to the first £2,000 each year, increasing costs for many employers with higher-paid workforces and bonus schemes.

Whilst 2029 may sound a long way off, the issue for HR and reward teams is that salary sacrifice is often built into pension design, payroll systems, and wider remuneration strategy. So what exactly changes in 2029, which employers are most exposed, and how significant could the additional cost become? We’ll get a view from a tax lawyer helping clients prepare for the changes. 

What is striking is that employers already appear to be reacting. New research by Standard Life suggests 39% of employers currently offering salary sacrifice arrangements are now less likely to continue offering them once the cap takes effect, whilst 11% say they have already decided to withdraw schemes altogether. The concern appears to be focused particularly on the increased employer NICs cost and the wider challenge of redesigning reward structures which, in many organisations, have relied heavily on salary sacrifice for years. That points to a much bigger issue for HR than simply pensions tax. For some employers, this could mean fundamental changes to reward strategy, bonus sacrifice arrangements, and pension design more broadly. 

So let’s get a view on this. Earlier I caught up with tax expert Chris Thomas who joined me by phone and I began by asking him to explain exactly how the new cap will work in practice.

Chris Thomas: “So the key thing that's changing is essentially the National Insurance position, because currently if an employee has got a salary sacrifice arrangement in place for pension contributions, the effect of that is they give up a slice of their salary and therefore they save both the income tax and also the National Insurance contributions on that - that would be the employee contributions and also the employer saves their contributions as well - and then, effectively, the employer makes a pension contribution instead which is completely free of income tax and NICs. So as things stand, it's very tax efficient, you save income tax and also both employer and employee NICs. Now what's proposed going forward from 2029 is effectively a restriction on the benefit that you get for NICs purposes and, broadly speaking, the intention is that the NICs exemption would be capped at, effectively, the first £2,000 pounds of the contribution. So, let's say an employee decides they're going to give up £10,000 of salary in return for a pension contribution. At the moment, they'd get NICs relief on the whole of that. Going forward, the first £2,000 would still basically get the NICs exemption, but the rest of it would still be NIC-able even though, actually, they have given it up and taken a pension contribution instead.”

Joe Glavina: “Who is going to feel this most? Which employees and which sectors are really caught by the cap?”

Chris Thomas: “So I think this is primarily going to hit employers who've got significant populations of more highly paid employees because lower earners, obviously, by implication, are likely to be making lower pension contributions. So for example, if you've got someone who's just on auto-enrolment, the set amount that that will be automatically contributed, anyone under £40,000 who is on auto-enrolment minimum wouldn't go above the £2,000 threshold anyway, so they wouldn't be affected. The people who are likely to be more affected, I think, are the higher earners, so your more senior professionals, executives. Sectors that are most likely to come across this would be, for example financial services where you've got quite a lot of more highly paid individuals, professional services, technology as well, they're the obvious ones that spring to mind. But this isn't just necessarily salary that's being sacrificed because people sometimes sacrifice bonus for pension contributions as well so this could also impact those sectors who do pay bonuses and currently say to employees, well, you know, you can put this into your pension scheme. They'll still be able to do that, and they'll still get the income tax relief in the same way, we understand, but the NICs benefit will be limited.”

Joe Glavina: “How big could the cost impact be for employers. Is this marginal or material?”

Chris Thomas: “I think it could be quite material for some employers. It would depend to some extent on the profile of your of your employees. If you've got a lot of employees who are on quite low, or minimum wage, or relatively less well paid, the impact on them is going to be pretty limited as we said a minute ago, but if you're an organisation which has got significant numbers of higher remunerated employees then it will be a more significant effect. If you take, for example, somebody who is currently paying a £10,000 pension contribution through salary sacrifice, assuming that person is a higher earner then the effect of losing the NICs relief would be effectively an extra £200 pounds for them and for the employer the cost for them would be £1,500. So it actually will probably hit the employer hardest of all because usually, particularly in the case of higher earners, it's the employer NICs that’s the bigger number and therefore the bigger saving. Of course, in some cases the employer will share that with the employee. It's quite common, I think, in a lot of organisations that the employer says, well look, if you make your contributions through salary sacrifice we'll share with you some of the employer NICs saving that we're making. In those cases, of course, there will be potentially a bigger impact for employees who will be losing out and there's therefore a question for employers as to what, if anything, they might think about doing in relation to that.”

Joe Glavina: “Finally, Chris, what’s your takeaway message to employers?”

Chris Thomas: “I suppose the first thing to say is, don't panic and start making changes immediately off the back of the Budget because you've got, effectively, several years to think about how best to deal with this, and the NICs savings will continue as usual up until 2029. Having said that, equally, it would be a bad idea just to put it on the back burner and not think about it until 2028 because we all know that changes can take quite some time to implement if you are going to need to make changes. So I suppose the first thing to do, really, is to quantify, work out the numbers, as to actually how affected are you by this, which, as we said before, will depend to some extent on the nature of your employee population and the earnings profile. Work out what the cost of it actually is for the employee position, and also for you in terms of employer NICs. Then, I suppose, just think about what changes you might want to make to remuneration and pension contributions going forward, but remembering that there will still be some benefit to be had from salary sacrifice so it's unlikely to be desirable to remove it completely, but there might be things that need doing with regard to updating your contractual terms, or changing payroll systems, or possibly thinking about changing the structure - if you've got new employees coming on board - changing the structure of what it is you're offering with regard to pension contributions from the get go.”

Chris and the tax team are currently helping a number of clients to understand how this change affects their business and what to do about it going forward. If you’d like help with that then please do contact Chris – his details are on the screen for you. Alternatively, of course, you can contact your usual Pinsent Masons adviser.