In a bid to raise revenue and fund spending commitments, chancellor Rachel Reeves announced several tax changes in her recent Budget.
Among the new policies was a change to the rules around salary sacrifice and pension contributions, coming into effect from 6 April 2029. This will affect individuals saving for retirement as well as businesses.
Read on to learn how.
The salary sacrifice scheme offers a tax-efficient way to pay pension contributions
Salary sacrifice schemes allow employees to give up a portion of their earnings in exchange for a benefit of some kind from their employer. This might include cycle to work schemes or company cars, as well as pension contributions.
Paying pension contributions through salary sacrifice could be more tax-efficient for employees and businesses.
How pension contributions work without salary sacrifice
If you are not enrolled in a salary sacrifice scheme, HMRC typically calculates the amount of Income Tax and National Insurance contributions (NICs) you pay based on your salary.
Then, your portion of the pension contribution is taken from the remaining funds. Employers also pay their contribution directly into the pension on your behalf.
How paying pension contributions through salary sacrifice works
When you pay into your pension through salary sacrifice, your earnings fall by an amount equal to your contribution. Your employer then pays the full sum, including their portion, directly into your pension.
For example, if you earn £60,000 and pay an 8% pension contribution, 5% from you and 3% from your employer, the total contribution would be £4,800.
If you paid into your pension through salary sacrifice, your earnings would fall by 5% (£3,000), as this is your portion of the contribution. Your employer then puts the full £4,800 into your pension.
This means that your pension contribution remains the same, but your salary is now £57,000.
Consequently, as your Income Tax and NICs are calculated based on your lower salary, you would pay less. Because your employer pays NICs based on your salary, they also make a saving.
This means that paying pension contributions through salary sacrifice is advantageous for both employers and employees. As an employee, you could see your take-home pay increase or may decide to reinvest the saving in your pension.
Employers will benefit from a reduction in the costs associated with hiring employees.
However, during the Budget, the chancellor announced upcoming changes that could limit the tax benefits of salary sacrifice.
From April 2029, National Insurance contribution relief from salary sacrifice will be limited to contributions up to £2,000
While salary sacrifice is beneficial for businesses and their employees, it reduces tax receipts. According to the UK government, the cost of the salary sacrifice scheme for pension contributions was expected to rise to £8 billion by 2030/31.
As a result, the chancellor chose to cap the NICs relief to the first £2,000 of pension contributions per person. This will take effect from 6 April 2029.
The outcome of this policy for businesses and their employees depends on the level of pension contributions.
The new policy will disproportionately affect higher earners and their employers
Somebody earning £25,000 and paying an 8% pension contribution would pay in £2,000 each year. This means they would not exceed the cap on NICs relief, and they and their employer would reap the full benefits of salary sacrifice.
However, higher earners paying larger amounts into their pension are likely to be affected by the upcoming change.
For example, figures from Reuters suggest that an employee earning £125,000 and sacrificing a quarter of their earnings as a pension contribution would be £585 worse off because of the cap.
Furthermore, a business employing this person would pay an extra £4,387.50 in NICs after the salary sacrifice changes come into effect.
Salary sacrifice remains a tax-efficient way to pay pension contributions despite the upcoming changes
The announcement about salary sacrifice during the Budget was a blow to many savers and their employers who benefit from reduced NICs.
However, it is important to recognise that both employers and their employees still benefit from the NIC savings on contributions up to £2,000.
As such, salary sacrifice remains a tax-efficient way to pay pension contributions, albeit with reduced benefits after 6 April 2029.
Additionally, the support of a professional financial planner can help you navigate these changes. We can discuss alternative options for building tax-efficient retirement savings and if you are a business owner, we can explore ways to manage your tax liability.
This means you can still reach your financial aims despite changes to the salary sacrifice scheme.
Get in touch
If you are concerned about changes to salary sacrifice or any other announcements in the Budget, then please do get in touch with us at DBL Asset Management.
Email enquiries@dbl-am.com or call 01625 529 499 to speak to us today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.