What you can do about changes to salary sacrifice

Salary sacrifice has hardly been out of the news since the November Budget. It’s a formal agreement between you and your employer to lower your headline salary in return for pension contributions. The salary sacrificed up front is then exempt from National Insurance (NI) deductions for both you and your employer and in some cases, your employer might even share all of some of their NI saving with you.

What changes are coming? 

From April 2029, there will be a £2,000 cap on the amount of salary exchanged that will still be exempt from National Insurance deductions. It’s not a limit on how much that can be sacrificed for pensions, but you’ll pay employee NI on the excess over the cap. Your employer will also see a bigger employer NI bill, although this should not impact your take home pay. 

Some people may think it makes sense to reduce their pension contributions as a result of this change or worry that they need to leave any existing schemes. But this change hasn’t taken away the large benefit of paying into a pension, which is income tax relief. And this income tax relief will still apply whether you’re in a salary sacrifice scheme, or not. 

What you pay into your pension can pull you out of higher rate taxes or one of the many punishing tax traps while also boosting your retirement savings. That’s because pension contributions lower your ‘adjusted net income’ which is the measure used for various allowances such as the child benefit clawback, and the £100,000 tax trap, where your tax-free personal allowance starts to reduce and other childcare payments are lost.  

Who will be affected? 

HMRC data suggests 3.2 million employees are currently in salary sacrifice agreements to make their pension contributions over £2,000.  

Due to the way employee NI works, the deductions will be 2% of the contribution over the cap for higher earners, but up to 8% on the excess for people earning below £50,270.

So, there’s a danger that those earning at or around the £50,270 higher rate tax will feel the biggest dent as a proportion of their take home pay. 

Employers will be hit with a straight 15% NI charge on the excess, meaning the higher the earner, the higher the potential hit for them. 

This is illustrated in the example table below, which assumes employees are using salary sacrifice to make a personal contribution of 6% of their original salary. 

Should I change what I pay in to my pensions? 

It’s important not to stop your pension contributions as a reaction to the new rules and try not to reduce them at all if your wider situation has not changed. The reality is that with income tax relief and some NI relief, there’s still a big incentive to pay into a pension through salary sacrifice – it’s just not as big as it was. What you pay into pension will still be exempt from income tax, and pensions contributions are your best weapon against the continued freeze of tax allowances and thresholds.  

Many people have asked if there is a limit on salary sacrifice in general, or how to make the most of the NI exemptions on offer now, before the 2029 changes come into force. It’s likely we’ll see an increase in the sacrifice of regular salary and ad hoc payments like bonuses whilst the extra NI savings are on the table, and it’s hard to see employers refusing this if it saves them 15%, too.  

Here are some key points to consider: 

• Pension salary sacrifice is a formal arrangement that lowers your headline salary in exchange for a pension contribution. 

  A lower salary can affect other areas of your personal finances, such as eligibility for a mortgage, but it’s also not possible to sacrifice salary to the level that it will bring your hourly earnings below the national minimum wage rate. 

• Take care not to box yourself in. Employers offering regular salary sacrifice schemes will usually only allow changes once a year or other set interval.

  Many use the anniversary of the pension scheme or the company business year, only allowing other variations on certain life events outside of this. 

• The new cap's introduction in 2029 is also a long way off. There’s plenty of change that could happen in that time, so a wait and see approach might be better than any big, immediate changes.  

  Making a drastic decision like choosing to retire early simply to avoid the change has long lasting financial implications. You should only do that if you’re certain you have sufficient income to live on for your entire retirement.