Research published this week by HM Revenue & Customs (HMRC) suggests that the government could cut back on the tax benefits of salary sacrifice arrangements, according to industry experts.
The research – contained in a report titled ‘Understanding the attitudes and behaviours of employers towards salary sacrifice for pensions’ – was conducted in 2023 under the previous administration.
It surveyed employer attitudes to salary sacrifice and reaction to different ways in which the tax benefit could be reduced.
Steve Webb, partner at pension consultants LCP and a former pensions minister, said the current government’s desire to raise revenue was “even more acute today” than it was when the research was initially commissioned.
“This research suggests that changes to salary sacrifice are firmly on the agenda, and likely to be considered as a potential revenue-raising measure.”
Steve Webb, LCP
Although chancellor Rachel Reeves has yet to set a date for the 2025 Budget, LCP said the research’s publication was a clear indication that changes to salary sacrifice were being considered.
This week, the International Monetary Fund revised up its economic growth forecast for the UK but warned that the chancellor could not afford to miss the government’s target to balance spending with tax revenue, in part due to the interest on government bonds increasing.
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Timing of publication ‘very revealing’
“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,” Webb said.
“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.”
In the immediate aftermath of Reeves’ first Budget, delivered at the end of October last year, experts forecast a spike in interest in salary sacrifice arrangements following an increase in employer national insurance contributions.
“Any move to reduce or remove the benefits of salary sacrifice would be a blow to both employers and pension savers, potentially leading to lower retirement savings outcomes.”
Kate Smith, Aegon
Kate Smith, head of pensions at Aegon, warned: “Any move to reduce or remove the benefits of salary sacrifice would be a blow to both employers and pension savers, potentially leading to 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.”
What the research said
HMRC’s report – authored by independent firm IFF Research – involved surveying more than 50 employers, the majority of which already used salary sacrifice.
As well as collecting views on the concept, the research also put three hypothetical scenarios to employers to gauge their reactions to reductions in the tax benefit of salary sacrifice.
The three scenarios were:
- Removing the national insurance exemption for sacrificed salary for both employers and employees
- Removing national insurance exemptions for both parties and the income tax exemption for employees
- Removing national insurance exemptions above a £2,000-a-year threshold
Employers were more positive towards the third option with a capped approach, but were particularly negative towards removing the tax benefits altogether.
“I cannot see any employer continuing with the salary sacrifice scheme, if what is being sacrificed is then being taxed as well as [having] national insurance levied.”
Respondent to HMRC research
One employer quoted by the report described removing the national insurance exemptions as “a backward step”.
Another said the second option, which would raise employee costs even more, could remove salary sacrifice from the pensions landscape “in one fell swoop”.
“I cannot see any employer continuing with the salary sacrifice scheme, if what is being sacrificed is then being taxed as well as [having] national insurance levied, whereas paying through a traditional gross salary scheme would receive tax relief,” the respondent said.
The appeal of salary sacrifice
Salary sacrifice involves employees receiving lower take-home pay, which reduces their income tax and national insurance bills. Employers then pay the amount by which the salary is reduced directly into the employee’s pension scheme.
As employer pension contributions are exempt from national insurance, this can reduce costs for companies.
An employee earning £40,000 a year using a salary sacrifice arrangement for pension contributions – whereby take-home pay is reduced and additional contributions are paid into the scheme by the employer – would save themselves and their employer £460 combined in national insurance contributions, according to wealth management firm Evelyn Partners.
Gary Smith, financial planning partner at Evelyn, said that, while it was “far from certain” that the government was considering changes to salary sacrifice, it would also be “surprising” if it was not being looked at.
He said: “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.”
