Millions of workers in the UK could see their take-home income shrink or their pension savings reduced under proposed changes from HM Revenue and Customs (HMRC). The government is currently reviewing the tax advantages of salary sacrifice pension schemes, a system widely used to help both employees and employers reduce their tax and National Insurance contributions.
According to new research published by HMRC, these benefits may be scaled back or removed entirely as part of broader efforts to close a significant financial gap projected to reach £30 billion. Should these changes be implemented, it is estimated that a worker earning £35,000 annually could lose up to £560 each year, while employers might incur an added cost of £241 per employee.
Understanding How Salary Sacrifice Schemes Work
| Abolish both Income Tax and NI exemptions | Average loss of £560/year | Extra cost of £241/employee |
| Remove only the NI exemption | Employee loses £200+ | Similar employer cost increase |
| Remove the NI exemption above £2,000 contribution | Affects higher earners only | Partial employer burden |
Salary sacrifice is a voluntary agreement between an employee and their employer where a portion of the employee’s gross salary is exchanged for non-cash benefits, most commonly pension contributions. The amount sacrificed is contributed directly to the worker’s pension, before tax is calculated, allowing both parties to save on tax and National Insurance.
This system has gained popularity for its dual financial advantages. Employees benefit by reducing their taxable income, which lowers both income tax and National Insurance contributions. Employers, on the other hand, see savings through reduced National Insurance liabilities, making it a favourable option for larger workforces.
What Changes Are Being Proposed by HMRC?
The HMRC study outlines three possible scenarios, each with differing financial consequences for workers and employers. While no decisions have been finalised, the government is considering:
- Scrapping both income tax and National Insurance reliefs entirely, resulting in an average loss of £560 for employees and additional employer costs of £241 per worker.
- Removing only the National Insurance exemption, which could cost employees more than £200 annually and also raise employer expenses.
- Limiting the NI exemption to the first £2,000 of contributions, primarily affecting higher earners and partially impacting employer costs.
These proposals are still under review, but financial experts caution that one or more of them could be adopted in the government’s upcoming autumn Budget.
How Workers Might Be Impacted by the Shift
For many employees, especially those in middle-income brackets, changes to salary sacrifice could result in reduced pension contributions unless they compensate by increasing post-tax contributions. This would either reduce their immediate take-home pay or lower their future retirement income.
A mid-level employee who continues to contribute the same gross amount may find their net salary decreases, while others might choose to reduce their contributions altogether, potentially resulting in a smaller pension pot at retirement. The impact could be particularly challenging amid the current cost-of-living crisis, where many are already struggling to manage daily expenses.
Industry Voices Raise Red Flags Over the Proposed Cuts
Former pensions minister Sir Steve Webb has expressed strong concerns about the potential consequences, calling it a “double whammy” that threatens both short-term earnings and long-term financial security. He emphasized that any reduction in pension tax benefits could discourage essential saving habits among the working population.
Jonathan Watts-Lay, from the financial firm Wealth at Work, highlighted how many companies have embedded salary sacrifice into their core benefits offerings. In some cases, employers even redistribute the NI savings they gain back to the employees to enhance retirement funds. Disrupting this established structure could undermine the attractiveness of job packages and complicate talent retention strategies.
Why the Government is Exploring These Changes
The driving force behind these proposals is the government’s pressing need to address mounting financial pressures. Rising borrowing costs, increased social benefit spending, and pledges not to raise major taxes have created a fiscal dilemma. Without room to officially increase tax rates, adjusting pension tax relief could provide a subtler method of boosting revenue.
Estimates from the National Institute of Economic and Social Research suggest that the Treasury must generate approximately £30 billion in additional funds to meet its goals in the upcoming budget, making these changes a likely consideration.
Employers Voice Concern Over Additional Burdens
In a study conducted by HMRC involving 51 businesses, most employers expressed apprehension about the proposed reforms. Salary sacrifice schemes have become a vital part of their employee benefits strategies, offering cost-efficient ways to support staff financial well-being and enhance job satisfaction.
Employers highlighted two major concerns: the potential for increased administrative workload if rules change, and the reduced competitiveness of job offers should tax benefits be removed. Many currently use salary sacrifice creatively, either by passing on National Insurance savings to employees or using the scheme as a tool to attract new talent.
As the autumn Budget approaches, workers and employers alike are anxiously awaiting a final decision on the future of salary sacrifice schemes. Any adjustment to the tax benefits associated with pensions could have far-reaching consequences for savings habits, income levels, and employment packages across the UK. While no official policy has been implemented yet, growing fiscal challenges suggest these proposals are being seriously considered by the government.