BDO comments on salary sacrifice and national minimum wage changes

The Chancellor’s Budget has delivered long-anticipated restrictions to pension salary sacrifice schemes and confirmed further rises to the National Living Wage — moves that will raise costs for employers and employees alike. Caroline Harwood, head of employment tax at BDO, explains why the changes may reshape workplace pension strategy, squeeze payroll budgets, and intensify compliance pressures.

Commenting on the changes to pensions salary sacrifice schemes announced at today’s Budget, Caroline Harwood, head of employment tax at BDO said:

“The announced changes to salary sacrifice won’t have come as a surprise to many businesses. Indeed, a survey we carried out earlier this year found that over 90% of employers were expecting the chancellor to place restrictions on pensions salary sacrifice schemes. It’s also been at the top of the agenda for many employers I’ve been speaking to.

“A report published by HMRC in May this year examined three potential changes to salary sacrifice – removing the NIC exemption only, removing both the NIC exemption and the income tax exemption for employees, and removing the NIC exemption on salary sacrificed above £2,000 per year. Employees and employers may be somewhat relieved that the chancellor went for option three rather than the more costly alternatives. Furthermore the NIC exemption cap only relates to the “employee” element of the salary sacrifice based pension contribution – the employer element remains unaffected.

“However, there’s no escaping the fact that this change will increase costs for both employer and employee, potentially removing the incentive for employers to contribute generously to their employees’ pensions, reducing the motivation of employees to put money aside for their pension provision, and introducing a new admin headache for employers.

“In salary sacrifice schemes, employees forgo part of their salary which the employer pays instead into their pension as an enhanced pension contribution. This arrangement offers NIC savings for both employer and employee, as the sacrificed salary and employer contributions are exempt from both income tax and NIC.

“The chancellor today proposed that the amount of sacrificed salary which can benefit from NIC exemption will be capped at £2,000 per year starting from April 2029. This is later than we expected and is estimated to yield around £4.7bn in extra revenues in 2029/30 and £2.6bn in 2030/31 through a combination of the resulting increase in employees’ and employer’s national insurance on the element treated as the employee’s contribution (ie the amount sacrificed).

“Our calculations suggest that someone on a salary of £60,000 currently sacrificing 5% of their salary would stand to lose £20 per year in increased employee NICs from April 2029, while the employer would face an additional cost of £150 if there were no changes in applicable tax and NIC rates.

“For someone on £90,000 sacrificing the same percentage (5%), the employee NIC would rise by £50 per year with an additional cost to the employer of £375, again if tax and NIC rates do not change in the intervening period. These are not insignificant cost increases for employers currently offering salary sacrifice schemes.

“Currently, many employers share the benefit of their NIC saving with their employees by adding an extra top-up pension contribution – it’s hard to see such top-ups continuing if employers are not saving as much NIC.

“The chancellor has probably decided to introduce these measures from 2029 because of the administrative challenges involved. This time lag should give businesses time to work out how the changes will impact their costs and to decide how to respond although very few salary sacrifice (or “flexible benefits”) schemes commence from 6 April so employers will need to have plans in place for schemes starting earlier – many being aligned to the calendar year. The options might include withdrawing from pensions salary sacrifice schemes altogether if the administrative burden becomes too great, reducing employer pension contributions for new staff, changing the matrix of employee v employer contributions or perhaps restricting staff salary increases to fund higher employer contributions to core staff pensions outside of salary sacrifice arrangements.

“The OBR assumes that employers will seek to pass 76 per cent of the additional cost to employees, with 50 per cent passed to employees through lower ordinary employer contributions, which are not taxed, and 50 per cent through lower salaries and bonuses, which are taxed.

“Employees now have a three-year opportunity to take advantage of the current rules, perhaps by increasing the level of salary that they are willing to sacrifice.”

National Living Wage

“The UK Government has confirmed a significant increase in the National Minimum Wage rates, effective 1 April 2026. The National Living Wage for over-21s will increase by 50p per hour from April, to £12.71 – that’s a rise of 4.1%. And this comes after a 6.7% rise which took effect from April this year.

“Meanwhile workers aged 18 to 20 will get a bigger increase to the National Minimum Wage of 8.5%, to £10.85 an hour. This follows a 16.3% rise in April this year. And 16-17 year-olds will get a 6% increase to £8 an hour. This is on top of an 18% rise in April this year.

“These increases mark another milestone in the Government’s commitment to align wages with two-thirds of median earnings and are designed to address cost-of-living pressures.

“However, businesses with higher numbers of younger employees or a high proportion of the workforce on the minimum wage – notably in the retail, hospitality and care sectors – may find these costs hard to absorb. And any increases in the costs of employing staff may also suppress hiring intentions.

“One consequence of the increased rates over the last few years is pay compression. There is now a much narrower gap between those paid at the minimum rates and their supervisors or those in skilled roles. With many businesses unable to increase their overall workforce by the same percentage as the lower paid workers, the impact of the increase does not only impact overall employee costs, but has the potential to impact staff morale and retention.

“With more workers being paid at or just above the NLW/NMW rates, there is also more risk for employers to make inadvertent breaches in their overall NMW compliance. Getting things wrong can result in employers being named and shamed and being required to pay back employees at the current rates. Penalties of 200% can also be applied.

“Employers will now need to prepare and review their NMW compliance ahead of the April increase. They may also need to consider how to address the potential pay compression issues.”