With rumours swirling around the Budget, still more than two weeks away, the latest talk is of a clampdown on salary sacrifice use for pensions, which provides tax breaks for both employees and employers.

The last time salary sacrifice was slashed back in April 2017, then chancellor George Osborne chose to leave pension savings out of the mix. This time pension savers may not be so lucky.

At current figures pension salary sacrifice costs £4.1bn a year in tax breaks – £1.2bn for employees and £2.9bn for employers – so could be viewed by the chancellor Rachel Reeves as a quick win to fill her fiscal gap, but it ‘would lead to a reduction in take home pay for millions of employees’, warned the Society of Pension Professionals (SPP).

The overall cost of funding tax breaks on pensions is a mighty £24bn a year, including the 17% for salary sacrifice schemes alone, so it seems inevitable that officials at the Treasury will be pouring over various options to cut this.

But it is widely seen as a vital tool to encourage pension saving, critical in the face of an ageing population and future concerns about funding the triple lock on the state pension.

Steve Hitchiner, chair of SPP’s tax group, said: ‘Changing salary sacrifice arrangements would lead to a reduction in take home pay for millions of employees who are saving into a workplace pension, with the greatest impact for those earning less than £50,284 a year.

‘It would also represent another sizeable cost to employers, despite the chancellor’s public commitment against this, and would undermine the critical role that employers play in supporting and promoting good quality pension saving vehicles.’

Around a third of private sector employees are signed up to salary sacrifice arrangements, and almost 10% of public sector workers. However, only 39% of UK employers offer these arrangements to all employees, according to figures from Nest, the National Employment Savings Trust.

‘Any changes will bring upheaval to a large number of workers with removal of the arrangement costing millions of employees hundreds of pounds a year,’ Hitchiner warned.

Changing salary sacrifice arrangements would lead to a reduction in take home pay for any employees currently making use of these arrangements unless pension contributions are reduced to allow for the national insurance contributions (NICs) increase.

The impact would be greater for those earning less than £50,284 pa, for whom employee NICs are 8%. For those earning above £50,284 pa, employee NICs are 2%, so the impact is less. However, salary sacrifice can also be seen as adding to social inequity as lower paid workers on minimum wage cannot benefit from these schemes. In practice SPP said salairy sacrifice is ‘not feasible for those with full-time equivalent earnings of around £20,000-£25,000 pa, depending on the hours worked’. On a simple equality basis, there is clearly a divide between the 30% of private sector employees who enjoy the tax break and the majority of employees who do not.

The SPP also warned of unintended consequences if salary sacrifice were abolished in its latest report, titled A Sacrifice Too Far?.

‘Employers would likely seek alternative ways to restructure reward packages to maintain tax efficiency, retain staff, and manage costs. For example, it may be more attractive for employers to offer new employees a lower starting salary, but with a non-contributory pension scheme. While some of the tax advantages would be lost, creative restructuring and tax planning is likely to occur,’ the report warned.

It also pointed to speculation that the government is looking at abolishing or reforming salary sacrifice for pension contributions, even more likely after HMRC published some employer research on the very topic earlier this year.

HMRC questioned employers about their views of salary sacrifice and proposed three potential options for reform, all of which were intended to restrict the use of the arrangements. This was met with a negative reaction, with employers stating that ‘any changes would cause confusion, reduce benefits to employees, and disincentivise pension savings’.

They were also concerned that HMRC’s plans would hit employee morale ‘badly’, and any changes would cost businesses to implement. At the time, the government made no comment and did not propose any changes to the current system. But the Treasury now has all the data it needs to base its decision.

In companies operating salary sacrifice for pensions, an employee gives up a portion of their salary in return for their employer paying an equivalent amount into their pension. Whilst they are funded by the employee, they are treated as employer pension contributions for income tax and NICs purposes.

The SPP also warned of the huge risk of reduced pension saving, saying it was the ‘most important’ impact. The government is so worried about the shortfall that it has revived the Pensions Committee to review the problem of pension inadequacy, SPP pointed out, adding that DWP figures showed that over 15 million people do not have enough savings for their retirement.

SPP Salary Sacrifice paper, A sacrifice too far?

 

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