Pension salary sacrifice under scrutiny: what proposed changes could mean for you

Rumours of changes to the tax treatment of pension salary sacrifice have emerged ahead of the upcoming Budget. 

While details remain unconfirmed, the possibility of a cap on National Insurance relief has prompted concern among pensions and long-term savings experts. 

Speaking about the issue, David Brooks, head of policy at Broadstone Corporate Benefits, has outlined how salary sacrifice works today, what a cap might look like and why policymakers risk undermining wider pension reform efforts.

How pension salary sacrifice works

Salary sacrifice, sometimes called salary exchange, allows employees to redirect part of their gross pay into a pension. 

In doing so, they forgo that portion of salary and receive an equivalent employer pension contribution instead. 

As Brooks explains, the mechanism brings two forms of tax advantage: “The individual saves their National Insurance contribution and so does the employer.”

In contrast, the more common method of contributing to a workplace pension involves employees paying from gross salary and receiving income tax relief only. Salary sacrifice adds an additional NI saving on top. 

For employers, the attraction is clear. “The big driver for employers is they get to save their national insurance, usually around 15%,” Brooks says. Some employers also choose to share part or all of this saving with staff.

Despite its financial advantages, salary sacrifice remains less widely adopted than might be expected. Brooks notes that take-up has grown in recent years but remains far from universal, even among those who could benefit most.

The rumoured policy shift

Reports in recent days have suggested the Government may introduce a £2,000 cap on the amount of salary that can be sacrificed for pension contributions while still benefiting from NI relief. 

Above this threshold, income tax relief would continue but both employee and employer National Insurance would be charged.

Although speculative, the idea is not without precedent. Earlier this year HMRC published a consultation exploring a number of reform options for salary sacrifice, from complete withdrawal to more limited adjustments. 

“Nobody was quite sure why all of a sudden HMRC published this,” Brooks notes, “but it now appears that modelling may have been revisited.”

Because HMRC’s consultation considered employer behaviour, administrative challenges and potential responses, the rumour has gained more traction than typical pre-Budget speculation. “We know they’ve done some thinking about this before,” Brooks says.

Administrative ease but behavioural risk

From a technical standpoint, implementing a cap would be manageable. Payroll systems could be adjusted without significant difficulty. 

The larger issue, Brooks argues, lies in communication and behavioural responses. Payslips would become more complex and employees would see a sudden reduction in take-home pay despite the same level of pension saving.

That could lead to predictable outcomes. “People will prioritise short-term thinking,” Brooks warns. 

“They’d much rather have pay in their pocket now to pay the bills. Pensions are always going to be the thing that gets deferred.” 

The result may be lower contribution rates, especially among those already concerned about living costs.

A clash with the push for better retirement outcomes

Brooks expresses broader concern that reducing incentives to save runs counter to efforts to improve pension adequacy. 

Policymakers across Government have acknowledged the need for higher contributions to ensure adequate retirement incomes. Yet limiting salary sacrifice could “erode overall confidence” in pensions, particularly for workers already sceptical about locking their money away.

He also highlights a potential disconnect within Government itself. With the state pension available regardless of asset wealth or income, the Treasury is increasingly neutral about private saving behaviour. 

However, other Government initiatives, including preparations for a new Pensions Commission, aim to strengthen the system. 

“It feels even more disconnected,” Brooks says, “that proposed tax changes could contradict emerging policy recommendations.”

Targeting concerns and impact on median earners

A £2,000 cap would affect a significant proportion of workers using salary sacrifice. 

Brooks notes that a median earner in their mid-30s contributing at minimum auto-enrolment rates via salary sacrifice would likely exceed the threshold.

This does not seem to match the Government’s self-stated ambition not to raise taxes on ‘working people’. 

This raises questions about who the policy change is intended to target. Raising the threshold would reduce the policy’s fiscal impact, potentially making it less worthwhile for the Government to pursue. This leaves the rumour in uncertain territory.

Waiting for clarity

Despite the conjecture, the underlying uncertainty leaves little scope for immediate action. 

With the Budget imminent, anyone concerned about the tax implications and a potential hit to their pension saving will have to wait for confirmation.

Whether the proposal proves to be a short-lived piece of ‘kite-flying’ or a substantive policy shift, the debate highlights the delicate balance between raising revenue and supporting long-term saving. 

If the Government intends to strengthen pension outcomes, it may need to consider carefully how any reform affects the incentives that underpin the system.

The full video interview with David Brooks is available on Octo Members.