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Millions of workers are able to take advantage of a scheme that allows them to boost their pension and pay less tax, and experts are urging people to “max out” this valuable perk before the rules are tightened.

Salary sacrifice lets you exchange some of your wages for a different benefit from your employer, such as a company car – or, in this case, pension contributions. You will then pay less tax and national insurance (NI) on your lower salary.

This week a report warned that millions of people are not saving enough for retirement and that without action “too many risk facing a cliff-edge drop in income” when they stop work, so this is something many employees can do that will make a real difference.

In the past few years there has been an explosion in the number of companies offering pension salary sacrifice as a benefit. However, the government has announced that from April 2029 it will restrict the benefits offered by these arrangements.

That gives employees almost three tax years to make full use what’s on offer before the changes take effect, “so taking advantage now really makes sense,” says Jason Hollands at the investment platform Bestinvest by Evelyn Partners.

For example, if you might be in a position to put more money into your pension in a few years’ time, you might want to consider bringing those plans forward.

It can also help alleviate some of the tax pain that can be the downside of getting a pay rise.

What is pension salary sacrifice?

It is where an employee agrees to give up some of their regular pay (or bonus) and redirect the amount they would otherwise receive into a different benefit – in this case, extra employer contributions into their pension pot.

These schemes can run alongside conventional workplace pension contributions – if your employer lets you make additional voluntary contributions, this might be through salary sacrifice.

Because the money you sacrifice comes out of your gross pay – before income tax and NI are deducted – you also lower the amount you owe the tax department.

Reducing your taxed earnings can have other advantages. The schemes also benefit employers, as they don’t have to pay NI on the money sacrificed. Some employers will pay part, or all, of their NI saving into the worker’s pension as well – thereby further boosting their pot.

How it could benefit me?

Here’s an example. Let’s say James earns £50,000 and gets a £5,000 pay rise, taking his salary to £55,000.

Most of that increase – £4,730 of it – sits above the current higher‑rate tax threshold of £50,270 (in England, Wales and Northern Ireland – tax bands are different in Scotland).

Normally, that slice would be taxed at 40%, with NI also due – meaning £2,062 goes to HM Revenue and Customs (HMRC) before other factors such as student loans are considered, explains the insurer Standard Life.

However, by paying the full £5,000 into his pension via salary sacrifice, James can avoid higher‑rate tax on that income, cut his NI bill and have the entire £5,000 added to his pension before tax.

Can everyone do it?

No – your employer has to offer it. However, a lot do: an estimated 7.7 million employees contribute to their pension via salary sacrifice, according to HMRC’s latest data.

If your employer offers it, ask how it works so you are clear about what your pay will be after you give up some of your regular salary. And ask whether your employer will pay some or all of its NI saving into your pension.

You will need to enter into an agreement with them – the contract should detail things such as how much you will sacrifice, for how long and what you will get as a benefit.

Check you can opt in or out of the arrangement – for example, if your circumstances change.

If your employer does not offer this option, or you are not sure, talk to the pension or HR department or your union or staff rep.

What is changing?

From April 2029, any salary-sacrificed pension contributions above £2,000 a year will no longer be exempt from employer and employee NI.

Put simply, from that date, if you pay into a pension using salary sacrifice, you will pay NI on anything above £2,000.

For example, if you pay £2,400 into your pension using this method, NI will be calculated and paid on £400 of your contributions.

James’s NI “hit” after the cap takes effect in April 2029 isn’t huge: he would have to pay an extra £60 in NI if he sacrificed £5,000 for his pension compared with now, the Standard Life Centre for the Future of Retirement estimates. (His NI saving drops from £127 to £67.) However, the figure will vary depending on each person’s situation. Crucially, the new rules won’t change the income tax advantages that James enjoys by doing this.

In this example the cost to James’s employer goes up by £450 because of the employer NI savings lost on the contribution.

So what should I do?

If your employer offers this and you haven’t signed up, maybe now is the time to do so.

If you are already taking advantage of this perk, you may want to consider upping the amount you are paying in.

“You can max out [your contributions]. Anything you can sacrifice before April 2029 is worth a look,” says Steve Webb, a former pensions minister who is now a partner at the consultancy firm LCP.

He adds that there may be people who are thinking of putting more money into their pension in a few years’ time – perhaps when they have paid off their mortgage or are no longer paying childcare costs. “If you might be able to do that sooner through salary sacrifice, it’s going to be much more NI-efficient than if you do it after [April 2029].”

Hollands says that upping salary sacrifice contributions now “could be particularly important for those closer to retirement – aged in their 50s and 60s – who may be trying to catch up on building a pension fund. Taking advantage while they can is crucial, particularly if the employer passes on their employer NI saving.”

Meanwhile, there will be some workplaces that offer pension salary sacrifice for people’s regular pay but not for bonuses. Webb says workers might want to make the case that as the system is in place and nothing is changing for almost three years, perhaps the bosses would allow staff to exchange their bonuses for pension contributions.

Why is the government restricting this benefit?

Ministers say they are taking action because this perk “has disproportionately benefited higher earners”.

However, a freedom of information request made by Webb to HMRC has revealed that 1.2 million of the employees sacrificing more than £2,000 are basic-rate taxpayers.

He says pension salary sacrifice “is really valuable for basicrate taxpayers as they pay NI at 8% – for higher-rate taxpayers, it’s 2%”.

HMRC said in December that of the 7.7 million people doing pension salary sacrifice, 3.3 million give up more than £2,000 of salary. That means more than 40% of participating employees will be affected by the cap.

You mentioned other advantages?

Pension salary sacrifice can be an effective tool to help avoid some of the “nasty cliff edges” that can hit taxpayers as their income increases, Hollands says.

As highlighted previously, workers close to the £50,270 earnings threshold where the higher 40% tax rate kicks in could dip under it by using salary sacrifice pension contributions.

For some higher earners, it may reduce or even cancel out the tax penalty that many child benefit recipients have to pay. The high income child benefit charge affects parents who earn more than £60,000 a year.

So what’s the catch?

There are potential downsides to salary sacrifice that could affect, for example, some of those about to buy a home or have a baby.

These schemes involve effectively drawing a lower salary – which will probably mean a lower number appearing on payslips and bank statements.

David Hollingworth at the broker L&C Mortgages says that when someone applies for a mortgage the lender will look at payslips and deductions when assessing affordability. However, voluntary contributions to a pension may be considered “discretionary”, meaning they can be adjusted or stopped by the borrower if necessary, so they won’t necessarily be factored in.

Meanwhile, what you get from certain workplace and statutory benefits such as maternity pay and sick pay – plus things such as life insurance cover from your employer – can be linked to your salary. So reducing how much you earn could prove costly.