Salary sacrifice – should it be sacrificed?

Salary sacrifice pensions have become a popular choice for pension saving. They are beneficial for both individuals and businesses that often make huge savings by reducing their national insurance contributions. The basic concept is simple. It is well known that paying money into a pension attracts tax relief. However, it is less well known that how that money is paid into your pension scheme matters too.

Let’s assume that your salary is £20,000 and you pay £2,000 into a pension scheme. Currently you pay national insurance on the whole of the £20,000 (whilst getting tax relief on £2,000). However, your employer could offer to pay you £18,000 rather than £20,000 in salary. This way they only pay national insurance on just £18,000 rather than £20,000. Furthermore, you, as an employee, might avoid national insurance contributions too.

The costs of salary sacrifice to the Exchequer are obvious. The employee can save up to 11% of earnings and the employer 12.8% of earnings. Employers are not, of course, obliged to pay the national insurance contributions savings they make from the scheme into the employees’ pensions. Often employers that do make the payments will only pay part of the savings into the employees’ pensions with the justification that they are using the rest to cover the cost of running the salary sacrifice scheme. In addition to this, in some cases, the national insurance reduction has stopped the employee from being able to receive full state pension entitlements, although this is rare.

As it happens, the direct gain from salary sacrifice is much greater to those on lower earnings (because employee national insurance contributions are much reduced once the employee’s earnings are in the higher tax bracket). The gain to the employer is more or less proportionate to an individual’s earnings. Although, salary sacrifice is of greater benefit to lower earners, you could argue that it is, in the first place, advantageous only to those who work for the select employers that offer it, thus making it far from egalitarian.

The amount saved by employers by the Treasury not charging national insurance on employer pension contributions is £8.2 billion per year. This could finance a reduction in the main employer’s rate of national insurance of about 2%. The government should aim for a simple, flat tax system with few exemptions. Equalising the national insurance treatment of empoyer and employee contributions would be a step in that direction.