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With changes to salary sacrifice on the horizon, we explain why
now’s a good time to assess your pension arrangements and get
up to speed with tax compliance.
Employee pensions are confusing. That’s been highlighted by
the reaction to the recent announcement that the National Insurance
contributions (NICs) benefits of pension salary sacrifice will be
heavily limited from 2029. The press coverage on this tended
towards the apocalyptic. So what’s really happening when these
changes come in and what sort of action might employers take to
prepare?
This article also considers what else employers should be
thinking about. We see lots of employers make inadvertent payroll
errors with their employee pensions. When these are compounded over
years it can give rise to a hefty tax bill and / or damage the
relationship with employees.
“Salary sacrifice” and misconceptions from the Autumn
Budget
Under a “salary sacrifice” arrangement, employee
pension contributions are deducted from earnings before deductions
for PAYE and NICs, allowing full relief at source.
In the most recent Autumn Budget, Rachel Reeves announced a cap
on the NICs saving available through pension salary sacrifice, so
that that from 6 April 2029 only the first £2,000 per year of
employee pension salary sacrifice will be exempt from both employee
and employer NICs.
There seems to be fairly widespread misunderstanding about the
impact of this change. To help bust a few myths…
Nothing is happening immediately – the change will be
effective from 6 April 2029.
The change does not cap pension contributions at
£2,000.
The change does not limit income tax relief on pension saving
to £2,000.
There will be no impact on employer pension contributions, or
any other aspects of pension taxation.
If it’s helpful to think about the actual impact in
financial terms I gave some practical examples in my earlier
article on the topic (available here).
While the change will reduce the advantages of salary sacrifice
for both employees and employers, salary sacrifice remains the most
tax efficient way to make employee pension contributions. But
it’s definitely going to get a bit more fiddly to operate when
the NIC changes come into effect, so employers are entitled to ask:
is it worth the hassle?
What should employers be doing?
Given that the changes aren’t coming in for a while,
employers have the luxury of taking a step back and assessing their
pension arrangements. For some this might prompt an attempt to
consolidate different pension arrangements that have accumulated
over the years (e.g. from business acquisitions).
Even if you only have one pension provider and employees are all
on broadly the same arrangements, you might want to consider
alternatives, especially if salary sacrifice no longer seems
‘worth it’.
Alternative 1: “Net pay” payroll arrangements
Under a (confusingly named) “net pay” arrangement,
employee pension contributions are deducted from earnings before
deduction for PAYE, allowing income tax relief at source. There is
no NIC relief.
Clearly the lack of NIC relief means that this is a less
advantageous arrangement than salary sacrifice.
However, given a net pay arrangement can be slightly easier to
implement we might reasonably see an increase in the use of this
arrangement from 6 April 2029, where the NIC benefit of salary
sacrifice arrangements will be limited to £160 per year for
employees and £300 per year for employers.
Alternative 2: Standard “Relief at source”
The (almost even more confusingly named) “relief at
source” arrangement is one where employee pension
contributions are deducted from net earnings after deduction for
PAYE and NIC. The pension provider then applies a “gross
up” to give basic rate tax relief, with any further tax relief
needing to be claimed from HMRC (either by contacting HMRC or
filing a tax return).
The lack of NIC relief together with this second step to claim
any higher/additional rate income tax relief means that these
arrangements are the least favourable for employees. However, their
existence endures as they are often the preferred (or at least
default) approach for many pension providers.
Common errors and remedial actions
Given the variety of options available it is perhaps
unsurprising that mistakes are made.
One of the more common errors we see is where employees
inadvertently benefit from “double” tax relief, through a
combination of (i) tax relief through payroll, together with (ii) a
tax gross up processed by the pension provider.
In practice this can happen where an employer switches payroll
or pension providers, or sometimes in the transition that follows a
business acquisition.
In such cases, employers will likely need to engage with pension
providers to reverse excess contributions and payroll providers to
correct submissions. They may also even need to recover underpaid
tax from employees. For obvious reasons this exercise is something
most businesses will want to avoid, and so it is important they
understand how their existing payroll arrangements operate in
practice. Another common error is information not being passed to
the pension provider and/or the payroll provider, which could lead
to pension contributions being missed altogether.
The key thing is to understand how your pension works and make
sure that your payroll operation and the information you send to
the pension provider every month is consistent. Is it full salary
sacrifice, or a mix of employer contributions with either ‘net
pay’ employee contributions or ‘relief at source’
employee contributions? If you identify any discrepancies between
your payroll and your communications with HMRC or the pension
provider it’s always better to fix them sooner rather than
later.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.