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Salary sacrifice schemes are a tax-efficient option offered by companies that enable workers to reduce the cost of paying into their pension arrangement.
But changes are on their way to the rules covering these popular plans. We look at how salary sacrifice works, when the rules change, and explain the considerations that you need to weigh up now to make the most of what can be a valuable benefit.
Salary sacrifice is a tax-efficient way for employees to contribute to a pension.
Not all employers offer a salary sacrifice plan. But where they do, it provides workers with an opportunity to give up - or sacrifice - some of their salary (or bonus payment) in the form of taxable pay.
This allows their employer to direct that same cash value of money into another arrangement instead. This is usually a workplace pension scheme. But salary sacrifice can also underpin arrangements such as ‘Cycle to Work’.
Opting for salary sacrifice reduces a worker’s taxable income, lowering his or her income tax and national insurance (NI) liability in the process. The employer also saves on NI and sometimes passes this saving back into an employee’s pension.
Until now, pension contributions made using the salary sacrifice option have been exempt from both income tax and NI making them tax-efficient for both worker and employer alike.
But from April 2029, the system is changing. NI savings on pension contributions made through salary sacrifice will be capped at the first £2,000 a year, with tax relief above this level limited to income tax only.
It will still be possible to pay more than £2,000 a year into a defined contribution pension through salary sacrifice from this date. But amounts more than this figure will then be subject to NI. The NI rate is currently 8% on earnings below £50,270 and 2% on earnings above this.
It’s important to say that not all workers currently participating in a salary sacrifice scheme will be affected from 2029.
For example, take an individual earning £40,000 pa in three years’ time who pays 5% of their salary into a company pension via salary sacrifice. This works out to £2,000 a year, does not exceed the new cap, and means neither employee nor employer is required to pay any more NI.
But those who contribute more than £2,000 into their pension will face an extra NI bill. Say an employee earnt £40,000 pa, but chose to put 10% of their salary, or £4,000, into their pension. In this example, an amount worth £2,000 would exceed the cap and be subject to NI, resulting in an extra bill of £160 (worked out as 8% of £2,000).
These figures from Vanguard show how the rule change will affect employee tax bills.
Research from pension consultants Barnett Waddingham shows that nearly two-thirds of workers (62%) make use of salary sacrifice. But a similar proportion (63%) said they were not aware of the new cap being introduced.
Lucie Spencer, a financial planning partner at Evelyn Partners, says the change could disproportionately affect workers over the age of 50.
“By this stage in their careers, many individuals earn higher salaries and are often in the 40% [higher rate] or 45% [additional rate] tax brackets. People in their 50s typically increase pension contributions as retirement approaches, but the removal of NI savings above £2,000 significantly reduces the overall efficiency of salary sacrifice for higher earners,” she warns.
As a result, it’s also possible employers will decide to reduce extra pension top-ups they currently give or may even question whether salary sacrifice remains a pillar of their workplace pension scheme.
An alternative way of structuring a pension arrangement is ‘relief at source’, which is cheaper to run than salary sacrifice. Through the relief at source scheme, higher-rate taxpayers often need to claim extra tax relief through self-assessment - something many people overlook.
Only 15% of employees make salary sacrifice contributions above £2,000, according to figures from the Institute for Fiscal Studies. But this rises to 17% for people in their 50s, then drops back to 10% for those aged over 60.
It’s understandable why the over-50s are in a sweet spot to take part in salary sacrifice. Outgoings such as childcare costs may be behind them. What’s more, the burden of mortgage payments could have diminished, or disappeared completely, by then with the home loan having been paid off.
Career progression could also be at a peak offering more discretionary income and the opportunity to give pension plans a final push before retirement beckons, suggests Justin King, a chartered financial planner and committee member of the Chartered Institute for Securities & Investment, a professional body.
“For my clients in their 50s and 60s, these are often the years when pension saving becomes much more focused. Retirement is getting closer, earnings may be at their peak, and many want to make the most of their remaining working years to build pension wealth. That means any reduction in the advantages of salary sacrifice is likely to be felt more keenly by this age group than by younger savers contributing at lower levels,” King says.
Lucie Spencer warns that faced with reduced incentives, some individuals may cut contributions, leaving retirement pots smaller than planned. This could be particularly concerning for those rebuilding pensions later in life, including the growing number of over‑50s who are divorced. Around 36% of divorces now occur in this age group, often involving pension sharing orders that already weaken retirement outcomes.
“Early retirement plans may also need revisiting. Many in their 50s use enhanced pension contributions to bridge the gap between retirement and state pension age. Reduced national insurance savings lower the achievable funding for that period, potentially delaying retirement or forcing lifestyle compromises,” she adds.
Former government pensions minister Steve Webb, now a partner at pension consultants LCP, says it’s well worth making the most of salary sacrifice while you still can, assuming it’s an option that’s available to you.
“Salary sacrifice is a very valuable NI break as a way of reducing the cost of paying into pensions. It’s set to be scaled back significantly after April 2029, so there is a lot to be said for considering how best to make the most of it before then,” he says.
“This could include opting in to salary sacrifice if you have not previously done so or using it more extensively if you are already a member. This could include, for example, sacrificing a bonus into your pension if your workplace allows it.
“You could also look at when you were planning to pay into pensions over the coming years and consider if any of those contributions could be moved before April 2029 if the numbers add up.”
Your employer should have explained how pension contributions are made when you joined the company or enrolled into the works pension scheme. You can always ask your employer’s HR or payroll teams if you’re not sure which pension scheme your employer offers. Alternatively, look on the company’s website or go through employee benefits documents that you’ve received. It should also be clear on your payslip if your salary has been reduced through salary sacrifice. On the section covering pension payments, the slip may refer to ‘salary sacrifice’, ‘SS’, or ‘SMART’. The latter is a type of salary sacrifice arrangement where the money you save on NI goes into your pension rather than increasing your take-home pay.
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