What do employers need to know about the pensions salary sacrifice cap?

The Government’s decision to cap the benefit of salary sacrifice on pensions at £2,000 per year was heavily trailed ahead of November’s Autumn Budget, and came as little surprise.

Now it’s confirmed, the question is: what can be done to preserve the benefit that currently saves many employers tens of thousands of pounds a year?

Here’s some things for employers to consider.

1. Build in time to plan, not to panic

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

That isn’t to say the cap shouldn’t be planned for. Any future Government may be supportive of a measure that saves money and is unlikely to be at the top of the voter agenda, but this isn’t the time to abandon salary sacrifice. There are still many benefits to be taken from it, and those who don’t use it should consider it.

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

2. Consider the nature of your workforce

The changes won’t affect many individuals. Assuming an employee contributes 5% of their salary, only those earning above £40,000 would be affected and the impact will increase gradually above this.

Higher earning individuals will see less of an impact as they have a lower marginal rate of NI (2%) but may be inconvenienced if salary sacrifice is withdrawn as an option (see point 5 below). Employers/sectors with higher salaries will be heavily affected though as they will pay NI at 13.8% on any salary sacrificed contribution over the £2,000.

3. 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.

4. Has your payroll provider plans to accommodate the assessment against this cap into their software

This has the potential to be an administrative nightmare in the early years. The onus will be on the employer to make sure the right level of NI is paid via PAYE, and this includes working out how much has been sacrificed into a pension.

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

5. Maintain clear communication with your staff

Engagement with pensions can be a challenge at the best of times, with unnecessary jargon and complexity clouding the appreciation of a key employee benefit. People may think this is a cap on tax relievable pension contributions and look to lower contributions or opt out.

6. 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 cap is purely about employees exchanging pay for contributions and makes salary that can be contributed to a pension a less efficient way of remunerating employees than a larger standard employer contribution.

Changing a scheme, for example, so the employer pension contribution is higher with an equivalent reduction in salary can be more cost effective for both employer and employee. As an example, instead of offering a scheme where the individual pays 5% of salary and the employer pays 5%, this could be restructured to 3% and 7%, or even 10% non-contributory.

If contributions exceed automatic enrolment minimums, there may also be scope to offer a cash allowance in-lieu of pension contributions. This payment would of course be subject to NI and tax, but it would be NI efficient if going to the pension. This is easy to implement for new hires, but existing hires would likely require consultation.

This does need careful consideration as it might reduce salary for some individuals that need it and care should be given to the specifics of the workforce and what people need and value. Employers should wait to see what the legislation guidance contains before taking action in case it presents any barriers.