Pension salary sacrifice cap explained: an employer guide

Now the decision to cap the benefit of salary sacrifice on pensions at £2,000 a year has been confirmed; UK employers will need to plan for upcoming changes.

So, what can be done to preserve the benefit that currently saves many employers tens of thousands of pounds a year? 

Here’s some key considerations. 

Plan, but don’t panic

First of all, there’s no need to rush or panic. The changes aren’t due until 2029 and with a general election in August 2029 at the latest, it might not even come into effect at all.

That said, the potential cap shouldn’t be ignored. Any future Government may well be supportive of a cost-saving measure that’s unlikely to be at the top of the voter agenda. However now is not the time to abandon salary sacrifice. It continues to offer significant advantages, and employers who haven’t yet adopted it should give it serious consideration.

According to Howden research, currently 68% of UK SMEs are not using salary exchange to boost pension contributions and after-tax pay. This means they may potentially be missing out on £2.7 billion in employer national insurance (NI) savings and £1.8 billion in employee savings.

Salary sacrifice doesn’t need to be complicated

Many employers are put off salary sacrifice as it’s seen as complicated to administer and explain. It’s true that it can be (especially with workers on short term contracts or with variable pay), but if approached in the right way the complexity can be dealt with. The key things to consider are setting clear rules for inclusion, having a clear record of any ‘sacrifice’ decision and communicating clearly (more on that below).

Assess your workforce profile

For many employees, the proposed changes will have little or no impact. Assuming a 5% employee contribution rate, only those earning above £40,000 are likely to be affected, with the effect increasing progressively at higher salary levels.

Higher earners may experience a smaller financial impact because their marginal National Insurance rate is lower (2%). However, they could still be disadvantaged if salary sacrifice is removed as an option (see point 5 below).

On the other hand, employers (particularly in higher-paying sectors) may feel the impact more significantly. They would be required to pay employer National Insurance at 13.8% on any salary sacrifice pension contributions exceeding the £2,000 threshold.

Understand where salary sacrifice still has a role

This is a complicated one. People can still sacrifice as much as they want (subject to wider pensions allowances), it’s just the NI relievable bit that is capped.

This means that salary sacrifice can still be beneficial for people looking to keep their salary at a certain level for things like retaining the personal allowance, child benefits, or funded childcare. 

It’s possible to reduce ‘adjusted net income’ for this purpose without using salary sacrifice, but it involves communication with HMRC. The same is true of higher rate taxpayers claiming back additional relief.

Check your payroll provider’s readiness

Has your payroll provider confirmed how they plan to build the cap assessment into their software? In the early years, this could create a significant administrative burden, as employers will be responsible for ensuring the right level of NI is paid via PAYE. This includes tracking how much salary has been sacrificed into a pension.

Most payroll systems should be able to handle this, as they currently generally record pre and post sacrifice elements, but it’s important to check once the legislation is confirmed.

Communicate clearly with your people

Avoid unnecessary jargon and complex language when communicating about pensions salary sacrifice. People may think this is a cap on tax relievable pension contributions and look to lower contributions or opt out. 

Consider wider pension scheme design

There is no limit to the NI savings that employers can make on contributions to pension schemes. It’s extremely unlikely one would be introduced due to the impact this would have on employers that participate in public sector defined benefit (DB) pension schemes.

This proposed cap is purely about employees exchanging pay for contributions. In effect, it makes salary sacrifice a less efficient way of remunerating employees compared with increasing standard employer pension contributions. 

Restructuring contribution models could therefore be a practical alternative. For example, instead of a 5% employee/5% employer split, a scheme could move to 3% employee/7% employer, or even a 10% employer-only (non-contributory) structure. In some cases, this may be more cost-effective for both parties.

Where contributions exceed automatic enrolment minimums, employers may also want to consider offering a cash allowance in-lieu of pension contributions. Whilst this would obviously be subject to NI and tax, it would be NI efficient if going to the pension. This approach is relatively straightforward for new hires, but changes for existing employees would likely require formal consultation.

That said, any redesign needs careful thought. Reducing salary to increase employer contributions may not suit everyone, particularly those who rely on their headline pay. Employers should assess the specific needs and preferences of their people and wait for detailed legislative guidance before making changes, in case practical barriers emerge.

If you’d like any further information the pensions salary sacrifice cap, please speak to your usual BW consultant.