Reeves told scrapping pension salary sacrifice would cost average earner £377 a year

Changes to salary sacrifice schemes, an option which HMRC hypothetically explored earlier this year, would cost millions of employees hundreds of pounds a year, a group of retirement specialists has told MPs.

Salary sacrifice for pensions – also known as salary exchange – is where an employee gives up a portion of their salary in return for their employer paying an equivalent amount into their pension. There is a National Insurance Contribution (NIC) saving to both employees and employers from this arrangement, which costs the Treasury around £4 billion a year.

Around a third of private sector employees make use of salary sacrifice arrangements, and almost 10% of public sector workers do so too, according to government figures.

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The removal or closure of these schemes to save the Treasury money would “cause confusion, reduce benefits to employees, and disincentivise pension savings”, the Society of Pension Professionals (SPP) has said in a letter to all 650 MPs – including chancellor Rachel Reeves.

Someone earning close to the average of £40,000 before tax who makes a pension contribution of £2,000 a year could have this contribution increased by £377 per year using a salary sacrifice scheme, with the same take home pay, according to the Society’s calculations, a rise of 17%.

Because of how salary sacrifice works, the negative effects of ditching the schemes would be greater for those earning less than £50,284 a year, the Society said.

Earlier this year, research into salary sacrifice commissioned by HMRC led to some speculation the government may seek to make savings by abolishing or reforming salary sacrifice for pension contributions, with an announcement potentially in the Budget.

But changing salary sacrifice arrangements would lead to a reduction in take home pay for any employees currently making use of these arrangements – unless they reduced their pension contributions too, the Society of Pension Professionals has said.

Steve Hitchiner, chair of SPP’s tax group, said: “Changing salary sacrifice arrangements would lead to a reduction in take home pay for millions of employees who are saving into a workplace pension, with the greatest impact for those earning less than £50,284 a year.

“It would also represent another sizeable cost to employers, despite the chancellor’s public commitment against this, and would undermine the critical role that employers play in supporting and promoting good quality pension saving vehicles.”

How does salary sacrifice work?

Salary sacrifice for pensions works by an employee exchanging some of their salary in return for their employer paying the same amount into their pension.

While funded by the employee, these contributions are treated as employer pension contributions for income tax and National Insurance purposes. This means pension salary sacrifice normally leads to savings in both the employee and employer National Insurance contributions.

This is because NICs are not due on employer pension contributions, whereas employee pension contributions are made after the deduction of National Insurance.

However, many employers share their NIC savings with their employees, meaning more is added to their pension, and salary sacrifice also allows employees to pay higher pension contributions for the same net pay.

The impact of scrapping pension salary sacrifice would be greater for those earning less than £50,284 a year, for whom employee National Insurance contributions are 8%. For those earning more than £50,284 a year, employee NICs on everything above that level are 2%, so the overall impact is less.

The Society of Pension Professionals pointed out that while there is a £4 billion cost to the government in providing salary sacrifice arrangements – £1.2 billion for employees and £2.9 billion for employers – there is also “widespread recognition that this is a positive investment that incentivises pension saving”.

Martin Willis, partner at pension firm Barnett Waddingham, said: “Rumours are again circling about changes to, or the scrapping of, salary sacrifice. While this could help the government recover National Insurance revenue, in practice it would be highly disruptive, complex, and introduce additional cost pressures for employers.

“Previous suggestions of a cap on salary sacrifice may help protect middle earners, but in reality this could add complexity while still squeezing employer costs and contribution rates. Alternatively, removing salary sacrifice entirely would hit average earners the hardest, particularly those relying on it to boost their pension savings.

“Policymakers should think very carefully before pursuing reforms that make it harder for ordinary workers to save for retirement.”