Rachel Reeves’ first Budget on 30 October 2024 left many employers reeling with the news that employer’s National Insurance contributions (NICs) are to rise from 13.8% to 15% from 6 April 2025. This was compounded by a lowering of the secondary threshold from £9,100 (£175 per week; £758 per month) to £5,000 (£96 per week; £417 per month) from the same date.

These measures increase both the earnings liable to employer’s NICs and the rate at which those contributions are payable. While some help is available in the form of an increase in the employment allowance from its current level of £5,000 to £10,500 for 2025/26, many employers will face considerably higher NICs bills from April 2025.

The rise will not only apply to Class 1 NICs payable on earnings such as wages and salary payments, but also to Class 1A and Class 1B NICs. Class 1A NICs are employer-only contributions payable on most taxable benefits-in-kind, and also on taxable termination payments and taxable sporting testimonials. Class 1B contributions are payable by employers in place of the Class 1 or Class 1A NICs liability that would otherwise arise on items included within a PAYE settlement agreement (PSA), and also on the tax due under the agreement.

The increase in Class 1A and Class 1B contributions to 15% from 6 April 2025 will increase the cost of providing employees with taxable benefits-in-kind, and also the cost of settling an employee’s tax liability on certain benefits-in-kind on their behalf by means of a PSA.

Salary sacrifice arrangements

Under a salary sacrifice, an employee swaps cash salary for a benefit-in-kind. In the past, it was possible to make good use of salary sacrifice arrangements to make tax and NICs savings by making use of tax exemptions for benefits-in-kind – by giving up cash salary for an exempt benefit, the employee saved tax and NICs on the cash foregone, leaving the employee better off than if they had funded the benefit from their net pay, and savings, while the employer saved employer’s NICs.

The introduction of the alternative valuation rules in 2017 removed the advantages associated with using salary sacrifice and other optional remuneration schemes for all but a handful of benefits. Under the rules, unless the benefit is one to which the alternative valuation rules do not apply, where an employee enters into an arrangement to swap cash salary for a non-cash benefit, the employee is instead taxed on the cash given up where this is more than the cash equivalent value of the benefit calculated under usual rules. If the benefit would otherwise be exempt (so the cash equivalent would be nil), the alternative valuation rules bite, and the employee is taxed on the cash foregone, rendering the arrangement ineffective as a tax-saving mechanism.

While the alternative rules make salary sacrifice arrangements ineffective for the vast majority of tax-exempt benefits, a small number of benefits fall outside the rules in respect of which the associated tax exemptions are not lost where the benefit is provided by means of a salary sacrifice arrangement or other optional remuneration arrangement. It is these benefits which provide an opportunity to save NICs and mitigate some of the impact of the forthcoming increases in employers’ NICs.

Pension contributions

Employer pension contributions are not caught by the alternative valuation rules. This provides an opportunity to use a salary sacrifice scheme to save both employer’s and employee’s NICs, enabling employers to mitigate some of the NICs hike applying from April 2025.

Pension contributions attract tax relief, but there is no corresponding relief for NICs purposes. So, for example, if an employee wants to make a £500 employee contribution into their pension from their pay, they will receive tax relief on their pension contributions (the mechanism by which this is achieved depending on the type of scheme), but no relief from NICs; the employee’s gross pay for NICs includes the salary used to fund the pension contribution. Therefore, the funds used to pay the employee’s contribution attract employee contributions at either 8% or 2% and employer contributions, which from April 2025 will be at a rate of 15%.

Instead, the employer and employee could enter into a salary sacrifice arrangement whereby the employee gives up £500 a month of cash pay in exchange for the employer making a contribution of £500 into their pension. As the employee’s cash salary is reduced, the amount of NICs that they pay will also be reduced. The saving will be £40 a month where the employee pays NICs at the main Class 1 rate of 8% and £10 a month where the contributor pays NICs at the secondary Class 1 rate of 2%. For employers, the saving is £69 per month per employee prior to 6 April 2025, rising to £75 per month per employee from that date – an annual saving of £900 per employee from 6 April 2025. The employee funds the pension contribution from their sacrificed salary, so there is no cost to the employer of providing the benefit.

Keeping it effective

Where this route is taken, it is important that the salary sacrifice arrangement is effective in HMRC’s eyes. For this to be the case, the employee cannot revert back to the higher salary at will. Rather, the employee’s contract must be changed to reflect the new arrangements, and the employee must agree to the contractual changes. If the employee wants to opt out of the salary sacrifice arrangement (which may only be permissible after a period of time or in response to certain lifestyle changes), the employee’s contract must again be changed to reflect the amended position.

In the event that the employee asks the employee to make a contribution to their pension on their behalf but remains entitled to their higher salary, there will not be a salary sacrifice arrangement and the NICs savings will not be forthcoming. Without the associated change to the employee’s contract, the employer is simply applying part of the employee’s cash pay on their behalf.

HMRC accepts that it may be necessary to change a salary sacrifice arrangement as a result of lifestyle changes which impact the employee’s financial situation, such as marriage, divorce, pregnancy or a partner’s redundancy. Consequently, the arrangement can allow for the employee to opt in or out of the arrangements in these circumstances without a loss of the NICs advantages.

Care must also be taken when using salary sacrifice arrangements for low-paid employees as after entering into the salary sacrifice arrangement, the employee must continue to be paid at least the national living wage or national minimum wage for their age

Other benefits

The use of salary sacrifice arrangements to save NICs (and also tax) is not limited to pension contributions. Employer pension advice, workplace nurseries and employer provided cycles and associated safety equipment also fall outside the alternative valuation rules.

Consequently, the employer and employee can enter into a salary sacrifice arrangement whereby the employee gives up some cash salary in exchange for one of these benefits without losing the associated tax and NICs exemptions. The employee will save tax and NICs, and the employer will save employer’s NICs.