Employers could face fresh financial pressures as speculation grows over potential government reforms to pension salary sacrifice schemes. This follows the publication of HMRC research, which has reignited concerns that changes may be on the table in the upcoming Autumn Budget.
The study, conducted in summer 2023 under the previous government, explored employer experiences, motivations, and attitudes toward salary sacrifice arrangements for pensions. It also examined how hypothetical reforms to tax reliefs — such as changes to National Insurance contribution (NIC) relief — might influence employer behaviour.
The research tested employer reaction to three different ways in which the benefit could be ‘hypothetically’ cut back.
With regard to the current system, employers were positive about salary sacrifice and thought it helped to retain employees as part of the overall benefits package. Some said they passed on the employer NI saving to their employees, but for others it was simply absorbed by the firm as a reduced employment cost.
In terms of potential changes to the system, the three hypothetical reforms tested were:
- Removing the NI exemption for employers and employees, resulting in employer and employee NI charges on the salary that the employee sacrificed.
- Removing the NI exemption for employers and employees, and the income tax exemption for employees, on the salary sacrificed.
- Removing the NI exemption but only on salary sacrificed above a £2,000 per year threshold.
Perhaps not surprisingly, employers were most negative about the second option, which involved removing both NI and tax breaks for salary sacrifice. Some employers said that this would eliminate the benefit of operating salary sacrifice and were unsure that they would continue to operate salary sacrifice for pensions in that scenario. The most favourably viewed reform was one where salary sacrifice would be capped, but allowed for smaller amounts of sacrificed salary.
Pensions industry experts say the fact that HMRC has commissioned research to test employer responses to potential changes to salary sacrifice suggests that there remains a significant risk of cuts in the forthcoming Budget.
Steve Webb, former pensions minister and partner at pension consultants LCP, said: “It is very revealing that HMRC has paid for research into the likely response from employers if salary sacrifice for pensions were to be scaled back. Although the research was commissioned under the previous government, the desire to raise additional revenue is, if anything, even more acute today. With a Chancellor reportedly looking to make up a multi-billion pound hole in the public finances in her Autumn Budget, this research suggests that changes to salary sacrifice are firmly on the agenda, and likely to be considered as a potential revenue-raising measure."
Tomm Adams, partner at tax and business advisory firm, Blick Rothenberg, commented: “HMRC has just published a report suggesting that the Treasury have pensions in their crosshairs in the Autumn Budget. It explores ways that HMRC could butcher pension salary sacrifice arrangements, or even abolish pension tax relief altogether.
“Many of us in the pensions industry who care about the general population’s retirement prospects are appalled at the short-sightedness to raise revenues today at the expense of financial stability tomorrow.
“There is a misconception at large that the pensions salary sacrifice is a form of personal income tax break, however it doesn’t provide any more of an income tax break than any other form of managing pensions contributions.
“The tax break connected with pensions generally is deferral on money that is locked away for years or decades, which is even then at risk, and there is tax still due on payments on retirement.
“There is an employer National Insurance Contribution (NIC) break at 15%, and an employee NIC break for salary sacrifice schemes, which is 2% for higher earners, and 8% for average and lower earners. In my opinion ‘regular’ non-salary sacrifice contributions should also attract such reliefs.
“In gross, the UK state pension provides only 21.7% of the average final salary in the UK, and even auto-enrolment only boosts that to 41.9%, significantly below global averages. Many other jurisdictions don’t apply social security in this way, and the UK is essentially taxing money that is locked away and at already at risk for most savers.
“It would be more transparent to roll the NIC exemption out to all, but this is very unlikely to happen under this government and is not something considered in HMRC’s report. However, removing this advantage would further increase costs for employers, and remove incentives for them to support their employees’ long-term financial wellbeing.
“There is a practice of employers ‘donating’ part of their saving to employees to further boost their retirement pot, which is especially relevant to higher earners who don’t get that big a saving from pension reliefs. If that change is made, there will be less pension contributions going in from higher earners as well.
“There are many other options instead of attacking pensions to increase revenues with a shorter-term impact, such as unfreezing fuel duties which would add £3bn to the nation’s bottom line. Hopefully, this is just the poorly timed publication of an outdated project, and not an indication of things to come.”
Kate Smith, head of pensions at Aegon, said: “Since the advent of auto-enrolment, many employers have used salary sacrifice to fund pension contributions. Interest in these arrangements has surged following April’s hike in employer NICs from 13.7% to 15%, alongside a sharp drop in the earnings threshold from £9,100 to £5,000.
“Salary sacrifice allows employees to exchange part of their salary for non-cash benefits, such as pension contributions, in a tax-efficient manner. These contributions are exempt from income tax and NICs, making them attractive and more affordable for both employers and employees.
“Any move to reduce or remove the benefits of salary sacrifice would be a blow to both employers and pension savers, potentially leading to and lower retirement savings outcomes. It could also impact the government’s growth agenda if there was a reduction in contributions flowing into growth assets. While no policy changes have been confirmed, the release of this research has intensified scrutiny ahead of the Budget.”
Gary Smith, financial planning partner at wealth manager Evelyn Partners, added: “This is a private HMRC consultation initiated in 2023 and it’s far from certain that the Treasury has any intentions around salary sacrifice, but it’s not the first time that SS has come under the spotlight as a potential area for shoring up the tax take, and given the pressures on the public purse it would be surprising if no one in Government was looking at this report.
“Salary sacrifice is a very efficient and effective way for employees to save into pensions, and it seems inevitable that watering it down – or dismantling it altogether - would hit pension saving, not just because the tax incentive would be diluted but also because faith in the pension system would be dented by more Government interference.
“Salary sacrifice substitutes pension contributions for earnings, so employees’ ‘get back’ their National Insurance as well as income tax. It’s arguably the case that it’s of more benefit to basic-rate taxpayers because, at 8% on earnings in the basic-rate band, National Insurance tends to make up a higher proportion of their overall tax liability, compared to higher and additional rate taxpayers, who pay an extra NI of just 2%.
“After the Chancellor’s Budget statement, when she announced an increase to employers’ National Insurance from April 2025, salary sacrifice arrangements for workplace pension schemes became more attractive for many employers, because of potential NI savings. You can therefore see why a cash-strapped Government might be tempted to deter salary sacrifice or make it less attractive, but if SS reform were to be seriously considered, employers who have introduced or started to introduce SS, as well as millions of employees, will be wondering which way to turn.
“Making pension contributions via salary or bonus sacrifice is a popular option for those whose earnings might fall into the 60% tax trap, a zone between £100,000 and £125,140 where the combination of high-rate tax and a tapered reduction in their tax-free personal allowance leads to a highly punitive marginal income tax rate, which for many families is worsened by the withdrawal of child-care benefits.
“The fault here lies with an unfairly structured income tax and benefits system that penalises people in this situation disproportionately for increasing their earnings. Removing a perfectly legitimate mitigation strategy - increasing pension contributions via SS - would seem harsh without reforming the disincentivising tax step itself.”
