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This week’s Budget could disrupt the comfortable, low-tax environment enjoyed by many business owners who pay pension contributions.

For decades, business owners have worked through their own private companies. This structure has offered numerous tax benefits, such as:

• The profits are subject to corporation tax at 19%.
• The director takes a minimal salary covered by their personal allowance.
• Further cash needs are extracted as dividends with no NIC due.
• The company invests all surplus cash in the director’s pension scheme.

But this could change with announcements in the Autumn Budget.

Salary sacrifice is on the block

There have been consistent rumours that there will be a Budget raid on salary sacrifice schemes, specifically for pension contributions.

In the last few years, HMRC has commissioned two research projects into salary sacrifice. The 2022/23 research asked employers about three hypothetical options:

1. Remove the national insurance contributions (NIC) exemption for pension contributions made by both employers and employees, but retain the income tax saving.

2. Remove the tax and NICs advantages for pension contributions altogether.

3. Cap the NICs exemption for both employers and employees on pension contributions at £2,000 per year.

Low cap on contributions

According to the Financial Times, option three was in the Budget planning papers, and making this change would raise revenue of up to £2bn per year.

However, in the latest Financial Times rumours, the changes to salary sacrifice schemes for pension contributions are expected to raise £3bn to £4bn per year. This points to a far more drastic redesign of the tax treatment relating to pension contributions provided as part of salary sacrifice schemes, perhaps a shift to option one or two above.

Current cap

Currently, an employer can contribute any amount into a pension scheme on behalf of an employee, and the entire contribution escapes the employer's NIC, but not necessarily income tax. 

Where the total pension contributions (from employee and employer) in the year exceed the individual’s annual allowance, the employee will be subject to an annual allowance tax charge calculated at their highest marginal tax rate. If this charge is £2,000 or more, the pension scheme may pay it under the ‘scheme pays’ procedure.

The standard annual allowance is £60,000. But taxpayers who have an adjusted annual income above £260,000 see their annual allowance tapered down by £1 per £2 over £260,000. However, the annual allowance currently can’t fall below £10,000 per year. 

Possible NIC charge

If the NICs exemption is lifted entirely for employers and employees, it will make pension contributions very unattractive and discourage many people from saving for their retirement. This surely can’t be the government’s intention. 

It’s possible that employers’ pension contributions will become subject to employers’ NICs but employees’ contributions will remain NIC-free and tax-free where the total is covered by the individual’s annual allowance. Employers would have to pay 15% of the value of the pension contribution to HMRC, which makes the provision of this benefit far more expensive for all employers.

It may also scupper the pension contribution option in all salary-sacrifice schemes.

Individuals whose company makes pension contributions on their behalf will be affected by any change to the NIC exemption for those contributions, whether or not there is a formal salary sacrifice scheme in place. 

The employer’s NICs will make the company’s pension contributions at least 15% more expensive, and possibly more if the employee’s NIC is also applied to the value of the contribution.

Will it happen?

There have been at least two detailed Financial Times articles on this Budget proposal, so my hunch is that employer pension contributions will become subject to the employer’s NICs to some extent. It’s a matter of when rather than if this will happen.

Any changes to the NIC or tax treatment will require certain pension scheme rules to be amended. I doubt whether this can be done in time for the changes to take effect from 6 April 2026, but I could be wrong.

What should business owners do?

In the short term, review the cash needs of the company and the owners. Could further pension contributions be made before any NIC changes come into effect?

Review the profit extraction policy and the long-term plans for the company. Consider whether surplus profits should be left within the company until the business ceases and the company is liquidated.

Whatever you do, don’t do nothing.

Noel Guilford