National Insurance rise, Pensions and Salary Sacrifice

National Insurance will become a reality from next month. This will in turn lead to an increased burden for employers and employees alike. How does salary sacrifice fit into this equation? What can it be done to minimise the effect of the NI rise? Our CEO Eduardo Chazan answers these questions in this post.

Your Auto Enrolment Pension and the NI rise

While there has been some doubt recently whether the National Insurance increase would go ahead, it is clear that from next month it will become a reality.

This leads though to key questions that have to be addressed:
  • What are the consequences if I am a business advisor, an employer or an employee?
  • How does salary sacrifice fit into the equation?
  • What can I do to minimise the effect of the NI rise?

The Increase

From April 2022, employees and employers alike will face a National Insurance (NI) rise of 1.25 per cent. From 2023, the tax will be renamed as a health and social care tax, with the £12bn raised earmarked to pay for the social care system in England.

But the figure of 1.25 per cent is deceptive, because the actual increase employees and employers will have to shoulder is more like 2.5 per cent. Employees will see a greater reduction in their salary, and employers will face higher NI costs.

And for businesses opting to increase wages so that their employees’ take-home salaries remain the same, the cost could be even higher, as any salary increases will be subject to extra tax, national insurance, and pension deductions. In these instances, the true increase could be in the region of 3.5 per cent.

As it stands, workers earning the average annual salary of £30,000 will pay an additional £255 in tax, and the Federation of Small Businesses has warned that the total cost to the small business community could be a staggering £5.7bn.

Salary sacrifice to increase dramatically, especially for pensions

Businesses can, however, mitigate against these NI rises in ways that benefit both employer and employee. All businesses that employ staff will have a workplace pension in place and some will offer advantages through salary sacrifice; however, the take-up has been modest. This will change if employers proactively explain the benefits to employees.

With salary sacrifice, an employee agrees to reduce their gross earnings by the same amount as their pension contributions, and in exchange, the employer agrees to pay increased employer pension contributions instead.

The result is that both the employee and employer pay less NI tax. The employee pays less Class 1 National Insurance Contributions (NIC) because they are waiving their right to a higher salary, which is compensated by the extra employer contributions to their pension. And the employer contribution is not liable to Class 1 NIC as it is payable to a registered pension scheme instead of a salary.

This is a great way for employees to boost their pension, as it ensures more of their earnings go towards pension contributions and less of them towards tax. And for business, it means significant savings on employee NI contributions that can go a long way to offsetting the NI hike.

For businesses with a company pension scheme already in place, the switch is relatively simple and there are few issues to address, including the fact that any change must not reduce an employee’s salary below the Living Wage and also that the change must be made contractually.

Critically, adopting salary sacrifice, especially at the new NI rates, will make a material difference to both the employee’s and the employer’s tax contribution. If an employer chooses to pass on any savings, this will benefit pension savings, especially for younger employees where typically they would see an extra £100-£200 a year in contributions to their pension.

Worked example

Let’s take an employer with 50 employees that pays the auto enrolment minimums (5 per cent employee contribution and 3 per cent employer contribution). Seven of those employees have earnings too close to the National Living Wage. Consequently, only 43 will be eligible for salary sacrifice and they have an average salary of £35,000 per year.

As of April 2022, if the employer calculates pension contributions using the qualifying earnings method, the business will save around £9,300 per year by switching to salary sacrifice, while each of its employees will save £191 per year. If the employer calculates pension contributions directly out of basic pay, it will save around £11,325 per year by switching to salary sacrifice, while each of its employees will save £232 per year.

It’s important to notice that employees are still investing exactly the same amount every year.  At the same time, their employer could use the savings generated by salary sacrifice to increase pension contributions or provide more benefits.

Key steps

  • Check how many of your employees are eligible for salary sacrifice (does the reduced salary fall below the National Living Wage? For those aged 23 and over this will be £9.50 from April 2022)
  • Check if the employment contracts allow for salary sacrifice, if not, then consider the benefits of drafting new ones.
  • Open a consultation period (usually six weeks) so that your employees can choose if they want to opt for salary sacrifice.
  • Prepare a salary sacrifice Q&A for your employees.
  • Make the change in payroll and decide how you want to spend the NI savings.

Most importantly, set up an account with us and we'll help you through the process.

This article, written by our CEO Eduardo Chazan, first appeared in Chartered Institute of Personnel Development's People Management magazine.