Salary sacrifice changes: the disproportionate impact on middle earners

The Chancellor’s Budget dominated the news, and salary sacrifice was a key part of that coverage. However, less noticed is how much these changes will affect middle earners, who often rely on salary sacrifice as one of the few simple, tax-efficient ways to save, as well as the impact on employers.

Here are three big headlines you may not have seen yet:

• Salary sacrifice changes hit some £50k earners as much as £140k earners
• Salary sacrifice changes hit some employers as much as the much-publicised NI increase from 13.8% to 15% earlier this year
• Salary sacrifice changes could prompt a nationwide review of pension arrangements ahead of 2029 (okay – we’re getting ahead of ourselves, but it might be a headline in a couple of years)

This blog unpacks each point to explain the impact of the salary sacrifice changes from April 2029 by looking at realistic scenarios.

The burden on individuals

Meet Jane, James and Julie. 

They earn £50,000, £60,000 and £140,000 in 2029, and each contributes 10% of their salary to their pension through a salary sacrifice arrangement.

For Jane, £5,000 of her salary is sacrificed into her pension, and £3,000 of this is above the new £2,000 cap. Therefore, it is subject to National Insurance, which she pays at a rate of 8% - a total of £240 extra NI.

For James, £6,000 is sacrificed into his pension, £4,000 of which is above the new £2,000 cap and is therefore subject to National Insurance. On these salary sacrifice contributions, he pays at a rate of 2% - a total of £80 extra NI.

For Julie, £14,000 is sacrificed into her pension. £12,000 of this is above the new £2,000 cap and is therefore subject to National Insurance, which, on these salary sacrifice contributions, she pays at a rate of 2% - a total of £240 extra NI.

The chart shows incomes up to £150k and the amount of extra annual National Insurance paid by employees at each income level, also marking the situation for Jane, James and Julie.

What we can see is that it’s people earning around £50,000, like Jane, who are hit the hardest by the salary sacrifice changes. She’ll pay three times as much extra tax as James, even though he earns more.

In fact, you have to look at earners in the “top 2%” who earn £140k+ like Julie to find people who pay the same amount of extra tax as Jane – £240. And in percentage of salary terms, £240 is clearly much smaller for Julie than it is for Jane.

This illustrates both how valuable salary sacrifice is for those earning £15k to £50k and, therefore, how big the hit will be from April 2029 when these savings are taken away.

The burden on employers

As for their employers, who also face an NI hit from the changes, the situation looks much more even, but the burden will be significant. Jane’s employer pays £450 extra NI; James’s pays £600; and Julie's employer will have to cough up £1,800.

As shown in the next chart, these are comparable to the extra employer NI resulting from raising the rate from 13.8% to 15% earlier this year, which put significant strain on many businesses.

What our clients are doing

These are high costs in tough times for businesses and individuals, and we’re expecting to discuss with employers whether generous pensions remain the best form of remuneration ahead of 2029, especially for those who offer pension contributions that are much more generous than the minimum required by law.

This review could go in a number of directions. Some will be cutting back on pension provision, but for others, pensions where employees don’t need to contribute at all will now look more attractive, so they could end up with something more generous for employees than before. Still others will be looking to use surplus from a legacy defined benefit scheme to fund their defined contribution pension offering, saving cash and, depending on how it is structured, potentially sidestepping some of the tax hit.

One thing is clear – the changes announced in the Budget will lead to a significant shake-up in pension savings.