Budget 2011: Merging of income tax and NI could spell the end of salary sacrifice

Steps taken by the government to merge income tax and national insurance contributions (NICs) could spell the end for salary sacrifice arrangements.

Following yesterday’s Budget when Chancellor George Osborne confirmed the government’s intention to create one overall tax, concerns have been raised that if national insurance (NI) does not exist the benefits of salary sacrifice, which results in NI savings for the employer and the employee, will be lost.

The proposed measure comes at a time when pension scheme costs could rise due to auto-enrolment and compulsory contributions, and contracting out could end final salary schemes if there is no second-tier state pension to contract out from.

Rob Thomas, associate at Barnett Waddingham, said: “The merging of income tax and national insurance could lead to the end of the current procedure for obtaining tax relief on pension contributions as we know it.

“The current system allows tax relief on the highest marginal rate of income tax for employees earning below £130,000 and soon to be restricted to a flat annual allowance of £50,000 per year. The treasury is unlikely to extend tax relief to a merged income tax and NI system.”

Ian Bell, head of pensions at Baker Tilly, said: “While the headline measures are with the long term in mind, what about pension provision in the private sector?

“There does not, on the face of it, seem to be anything to encourage employers to provide pension provision in the future. Contracting out rebates for defined benefit schemes will be cut by 0.5% to 4.8% from 2012, which could cost schemes £600 million per annum.

“But the real devil in the detail must come from the proposed flat rate state pension and the consultation on the merger of the operations of the NIC and tax regimes. Will this mean the abolition of contracting out rebates for private sector arrangements altogether and what could it mean for schemes that have put salary sacrifice arrangements in place?

“This could mean a large increase in the cost of funding those schemes in the future and encouraging employers to close them altogether. That does not sound particularly long term for those schemes and employees affected.”

The government plans to issue a consultation on the merging of NI and income tax. Osborne has said that the complexity of the change means it will take several years to fully implement.

For more articles on the Budget’s impact on benefits