Mark Pemberthy: This is a chance to make the most of salary sacrifice now and soften the blow when it comes.
In last November’s Budget, the government confirmed that National Insurance (NI) relief on pension salary sacrifice would be capped from 6 April 2029.
This will require employers to pay 15% NI contributions on sacrificed amounts above £2,000 and employees to pay NI contributions at their marginal rate between 2% and 8%. As of April 2029, the benefit long-valued for boosting retirement savings while protecting take-home pay will lose part of its efficiency, affecting 26% of basic rate taxpayers and around 290,000 employers.
However, amid mounting operational burden and associated costs, including a government estimated £20m in one-off administrative expenses, there is a glimmer of positivity.
A recent survey from Pensions UK found that 28% of salary sacrifice users say they are likely to increase contributions before the change comes into effect, while 11% expect to reduce when the change takes effect. The research shows that employees appreciate the advantages of salary sacrifice, indicating an opportunity for employers to embrace and reinforce the benefits ahead of 2029.
Embracing the benefits
While the proposed cap will reduce the benefits for some from 2029, one positive is that it provides reassurance that pension salary sacrifice will continue to be a permitted contribution option for the longer term.
An estimated 7.7 million employees in the UK use salary sacrifice to bolster their pensions, including those working for 70% of Gallagher's DC pension clients, but that still leaves over 10 million DC pension savers who do not save through salary sacrifice.
While some of those may have earnings that make salary sacrifice impractical, or work for micro businesses who may not have the resources to implement salary sacrifice, there are undoubtedly many UK employers who do not currently offer pension salary sacrifice who should review their decision in light of the government's long-term vote of confidence in salary sacrifice.
It is always good practice to review salary sacrifice processes regularly, and the Budget is a catalyst to do just that. Although salary sacrifice is a staple of workplace pension design, it is not always a default contribution method, but rather an active choice for employees. Automatic enrolment has shown the power of simplicity in uptake. The same applies to salary sacrifice, and it generally has a big impact on uptake.
However, salary sacrifice is not appropriate for all employees. The rapid rise in the National Living Wage has restricted the ability of many employees to participate in salary sacrifice benefits, whether that is pension saving, childcare initiatives or qualifying low-emission travel-related schemes. Employers currently operating on an opt-in basis should consider switching to an opt-out basis to maximise participation for eligible employees, and therefore the benefit for employees and employers alike.
The cost of living is still a concern for many employees and Gallagher's Workforce Trends Survey found that the biggest challenge faced by organisations is dealing with increasing costs within tight budgets. Pension salary sacrifice provides financial benefit to both employee and employer at a time when it has never been more important.
Even though National Insurance relief will be restricted to the first £2,000 of annual employee pension contributions from April 2029, normal rules apply for the next three years, and it will still be a material benefit to employees and employers beyond that date.
Indirect benefits
The supporting papers to the Budget confirmed that employees who choose to sacrifice salary to receive Tax Free Childcare or Child Benefit can keep doing so, indicating that some of the indirect benefits of salary sacrifice will still be effective after 2029, even beyond the £2,000 cap.
There are several taxable earnings thresholds that can significantly impact employees and their families. These include the tax-free Personal Allowance of £12,570, which is reduced by £1 for every £2 of adjusted net income over £100,000; £2,000 per year of tax-free childcare, which is available to parents if taxable earnings are below £100,000; and child benefit, which is subject to a tax-charge if earnings are over £60,000 per annum.
Salary sacrifice has the effect of reducing taxable earnings, and therefore may preserve access to some or all these benefits for some employees. This can be worth many thousands of pounds a year, depending on personal circumstances. In these instances, employees may benefit from saving more than £2,000 per annum into a pension by salary sacrifice after 2029, even though there will be no National Insurance relief on some of those contributions.
This is where low levels of pension confidence and financial understanding can be a limiting factor. Many people find pensions complicated, and salary sacrifice adds to the complexity. Clear communication and ongoing financial education can be crucial in helping employees make informed decisions – delivering better outcomes for employees and an even greater employee benefit impact for employers
Planning for a smooth transition
Come April 2029, the operational effect of the cap is likely to be felt acutely by payroll and benefits teams.
Employers will need to report pension salary sacrifice amounts through their payroll software and deduct National Insurance contributions when these exceed £2,000. HMRC will publish further guidance on this in due course and, as ever, the detail will be crucial. The delay until 2029 will give the payroll industry in particular time to identify how they administer this new requirement, but not all payroll systems may be able to accommodate these requirements by the deadline.
Employers should therefore engage with their payroll provider to keep updated on developments and understand how this will work for them in practice come 2029. Whilst there is no immediate panic, it will pay to monitor this in case some adjustments to managing the pension scheme need to be considered in the run-up to 2029 – no doubt it will come round fast.
Don't panic
At a time when 15 million people aren't saving enough for an adequate retirement, it's clear why industry bodies are concerned by the reforms and any misunderstanding or confusion in the meantime will only compound the issue.
Given the potential loss of National Insurance savings and potential operational burden, it is difficult to see any positives in this reform. But amid the frustration, there is a valuable opportunity to reinforce how well employees understand their pension contributions and the wider benefits for their financial circumstances. This is a chance to make the most of salary sacrifice now and soften the blow when it comes.
Mark Pemberthy is benefits consulting leader at Gallagher
