The Pension Tax Tweak That Could Cost Small Businesses More

The Government is weighing up a cap on one of the few tax breaks still widely used by employers and workers alike: the salary sacrifice scheme. 

At first glance, it looks like a clever way to raise £2 billion for the Treasury. But businesses and pension experts warn the policy could backfire badly, cutting into wages, pension savings and even jobs.

Here’s what’s at stake and why it matters for small businesses in particular.

What’s Changing

Under salary sacrifice, an employee agrees to give up part of their salary in return for a benefit, such as pension contributions. Because that money isn’t classed as salary, both the employer and employee save on National Insurance (NI). Employees boost their pensions while employers stretch their budgets a bit further.

Now, the Government is reportedly considering capping the amount that can go into pension salary sacrifice without NI being charged at £2,000 a year. Anything above that would attract the standard NI rates: 15% for employers and 8% for employees on salaries less than £50,270, or 2% on income beyond that. 

Who Benefits

From the Treasury’s point of view, this looks like a quick win. HMRC estimates that salary sacrifice costs the Government £4.1 billion a year in lost NI – £1.2 billion from employees and £2.9 billion from employers.

By capping the relief, the Government expects to raise about £2 billion. That’s money it could use to plug public spending gaps or fund other priorities.

Who Loses

That’s where small businesses come in. Pension experts warn that many employers could respond to the change by cutting back pension contributions to offset the higher NI costs – a worrying prospect given that four in 10 people are currently undersaving for retirement.

A business representative who spoke to the Financial Times on condition of anonymity was more blunt: “Essentially what we are talking about is another increase in national insurance . . . This could lead to companies lowering headcounts and investing less.”

For a worker on around £45,000 who puts 5% of their pay into a pension, the change would mean only a few dozen pounds more in National Insurance each year, with a similar rise in costs for their employer, based on estimates from accounting firm RSM.

Those numbers sound small until you multiply them across a workforce. For a 20-person business, that could mean several thousand pounds in extra costs every year. And for higher earners or more generous pension schemes, the hit could be far larger.

Why Small Businesses Should Care

Most small employers don’t have the deep pockets of the public sector, where average employer pension contributions are around 18%, compared with 6% in the private sector.

If tax relief shrinks, businesses will likely struggle to keep competitive pension packages – just as they’re trying to attract and keep staff in a tight labour market.

In response to news about rising unemployment – an issue that some experts fear will worsen with policies like these, Tina McKenzie, policy chair for the Federation of Small Businesses said: 

“Pushing small businesses out of employing staff with ever increasing regulation, litigation and tax will scar present and future generations who will keep finding the search for work incredibly painful. 

“We need a government that sides with the private sector – including people starting out on their own – not one that sides against it.

Salary sacrifice might sound like a technical detail, but for a number of small businesses, it’s a vital part of the pay and benefits puzzle. Limiting it could mean higher costs today and smaller savings tomorrow, for both employers and their teams.

In the rush to raise short-term revenue, the Government risks weakening the long-term foundations of small business growth and retirement security alike.