What salary sacrifice changes could mean for your pension

Yahoo

2 hours ago

The government has insisted recent reports indicating that it is considering changes to salary sacrifice pension schemes are "purely speculative".
It comes off the back of research published by HMRC in May that suggested the government was exploring reducing the tax and national insurance advantages by changing pension contribution schemes for workers.
While the research was commissioned by the Conservative government in 2023, the timing of its publication raised eyebrows because of it's proximity to Rachel Reeves's spending review on 11 June.
The spending review is when Reeves will lay out all government departments' budgets for the coming years. It could also be a strong indication as to whether the government will need to announce any increase to taxes later this year in the autumn statement.
Experts have told Yahoo News why the prospect of targeting salary sacrifice schemes would be so appealing for the government - and who would most likely miss out.
A salary sacrifice scheme is a formal agreement between an employee and employer in which the employee agrees to reduce their gross salary in exchange for a non-cash benefit - like a bicycle through the Cycle to Work scheme - provided by the employer.
In turn, as the employee pays for this through their salary, they not only pay less income tax, but their employer pays lower national insurance (NI) on the person's remaining take home-pay.
As national insurance is one of the main revenue streams for the government, this means that when an employee enrols in a scheme, the Treasury misses out on the extra tax.
When you use salary sacrifice for your pension, you agree to take a lower salary, and your employer pays the 'sacrificed' amount directly into your pension.
Like with any other salary sacrifice, because your official salary is lower, both you and your employer pay less in NI, and you pay less income tax on your earnings.
Salary sacrifice schemes are very popular, with 70% of UK pension schemes using them as the default method for contributions.
If the salary sacrifice scheme was limited or cut for pensions, the government could remove or limit these tax and NI savings.
For example, you and your employer might have to pay NI on the amount you sacrifice, or there could be a cap on how much salary can be sacrificed before the benefits are lost.
"Salary sacrifice along with income tax relief makes it very attractive to save into a pension," Stuart Price, Partner and Actuary at Quantum Advisory told Yahoo News. "For a lower rate tax payer £1 invested only costs them 72p, and for a high rate tax payer £1 invested only costs them 58p.
"If the provision of salary sacrifice is removed and hence national insurance relief is no longer provided these numbers increase to 80p for a lower rate tax payer and 60p for a higher rate tax payer," he added.
By removing or scaling back the tax and National Insurance (NI) exemptions that benefit employees and employers benefit from through salary sacrifice, the government could boost its revenue.
'Salary sacrifice along with the annual allowance often appear top of the list of options when the government needs to save money," Helen Morrissey, head of retirement analysis at Hargreaves Lansdown told Yahoo News.
The move would therefore be an attractive prospect for HMRC because it would generate "significant income".
"I would expect that they would be in favour of the removal of salary sacrifice on pensions," John Mullaly, a group risk and healthcare consultant from actuary Cartwright Employment Awards, told Yahoo News.
This may be even more significant as the government is just days away from its spending review, the process the government uses to set all departments' budgets for future years.
'The government may be tempted to turn its eye to salary sacrifice... particularly given the amount it costs in lost national insurance revenue," Martin Willis, a partner at independent consultancy Barnett Waddingham explained to Yahoo News.
While the government might benefit, employees earning the least would be the hardest hit.
"High earners may be insulated from any potential shift; the real impact would be on lower and moderate earners - particularly those using salary sacrifice to top up pension contributions," Waddingham said.
The move could also be an additional blow for businesses after the government's hike on national insurance rates for employers in the last Budget.
"Removing it now could disproportionately affect basic rate taxpayers and employers who've only just faced a rise in national insurance costs," Willis added.
Morrissey echoes this.
"At a time when employers are battling higher wage and NI bills, salary sacrifice might be seen as one way of reducing these costs – making changes will add an extra burden to struggling employers.'
While both employees and employers benefit from salary sacrifice arrangements, Mullaly said employers "do not pocket all of the savings."
"Quite often they use it to fund additional benefits to be used to attract and retain employees," he added.
Additionally, if salary sacrifices adversely affect pension pots, savers could be discouraged from putting away enough into their pension — which is unwelcome news when the figure for a comfortable retirement continues to rise.
According to the Pensions and Lifetime Savings Association (PLSA), to live a comfortable retirement in the UK, the estimated annual retirement income needed in 2025 is around £43,100 a year.
"There does seem to be a trend of focusing on increasing tax revenue at the expense of all other considerations, rather than focusing on the underlying social reasons for having things like a pension," Price said.
"The result of all of this is less money will be saved by employees towards their pension. Not a great thing when as a nation we are nowhere near saving enough for our retirement."
Added to this, the change in uptake could affect how and where pension funds invest their money.
"Many of the largest pension funds invest in our high streets, shopping centres and other real estate," Mullaly explained.
"With many high streets already under threat, any reduction in investment is only going to make the situation in this area worse."
While salary sacrifice reduction may be a highly attractive prospect for the government, it is clear that it would be far from popular.
The Society of Pension Professionals has already warned the government against salary sacrifice changes, writing in a statement that it would affect earners "very selectively".
Added to this, there would be some serious logistical hurdles to tackle to implement it.
Firstly, Willis said implementing these reforms after the new financial year has started "would likely be far from straightforward".
"Currently, salary sacrifice reward structures are set by employers, so implementing changes could be very messy, especially when it comes to capturing salary decisions for new hires or changes mid-year," he told Yahoo News.
"Today salary sacrifice is largely used to support improved pension saving, and is limited since the system was already tightened in 2017."
A government spokesperson said: 'These claims are totally speculative. HMRC regularly commissions independent research on all aspects of the tax system, and this research was commissioned under the previous government.
'We are committed to keeping taxes for working people as low as possible which is why, at last autumn's Budget, we protected working people's payslips and kept our promise to not raise the basic, higher or additional rates of income tax, employee national insurance or VAT."