- A salary sacrifice pension arrangement should not be agreed if the effect of this, such as a reduction in the employee’s pay, would lead to a breach of the national minimum wage legislation.
- A simple step, such as giving employees full transparency on which businesses the underlying funds are invested in, makes the concept of pensions feel more real.
- The recent announcement of increased National Insurance contribution rates from 2022 to 2023 has made salary sacrifice even more attractive.
Salary sacrifice pension schemes, whereby an employee agrees to reduce their earnings by an amount equal to their pension contributions, can be an attractive workplace arrangement. Sacrificing part of salary means an employee will pay less in tax and both the employee and the employer will pay less in National Insurance contributions (NICs).
Only half of British organisations use salary sacrifice for workplace pensions, according to research published by Workplace Pensions Direct (WPD) and YouGov in July 2021. So what do employers need to know about introducing a salary sacrifice pension scheme?
Do some initial planning
A salary sacrifice arrangement should not be agreed upon if a reduction in the employee’s salary would lead to a breach of the national minimum wage legislation.
Ian Neale, co-founder of Aries Insight, explains that where a salary sacrifice has been put in place to convert pay, subject to tax and class one NICs, to a benefit such as a pension contribution, HM Revenues and Customs (HMRC) has to be satisfied that it is effective. “The effect of the change must be that there is a variation of the employee’s contract that results in giving up the right to some of their pay in return for the non-cash benefit. This will involve the potential future remuneration being given up before it is treated as received for tax or NICs purposes,” he says.
These schemes can be a tax-efficient way to make extra contributions to a pension, and both employer and employees will pay lower NICs on a reduced salary. They also need to be properly documented by means of a salary sacrifice letter, which both parties sign.
Neale adds that this should demonstrate that the employee’s entitlement to cash pay has been reduced and a non-cash benefit has been provided by the employer. “An employer operating a pension scheme and enrolling workers using salary sacrifice is doing so outside the automatic enrolment provisions. Therefore an eligible employee who must be automatically enrolled, or a non-eligible worker who opts in cannot be required to commit to a salary sacrifice arrangement in order to become or remain an active member of the employer’s automatic scheme by the enrolment date,” he says.
To successfully implement this type of scheme, a possible first step is to address how well an employee understands what their workplace pension is and how it is invested, as well as demonstrating the long-term value and the positive impact it could have on their finances.
Jon Matthews, Tumelo’s head of partnerships, says that as staff like to be aware, in control and be able to trust their employer when it comes to their finances and pensions, transparency is key. “A simple step such as giving employees full transparency on which businesses the underlying funds are invested in makes the concept of pension feel more real. People recognise familiar names and brands, it builds trust by being open about what sacrificed income will be invested in, and it demonstrates the diversification of portfolios, so pension investing feels less risky.”
He adds that a further advantage is that an employee can be asked to express preferences on how the asset managers that run the pension funds should vote on issues relating to environment, social and governance issues. “Given an opportunity to have a voice on issues that resonate, members are likely to see more immediate value in the pension rather than framing salary sacrifice as a future and significantly more distant benefit,” he says.
After assessing its workforce to check that sufficient employees can take up salary sacrifice, an employer can choose to go ahead.
Robin Dargie, senior consultant at Quantum, notes that they must decide whether to retain NI savings made or to pass it on. “The employer might decide to keep the NI saving in year one to pay for the cost of implementation, but pass it on from year two. It can be introduced automatically, with employees being given the opportunity to opt out or organisations can decide that employees must opt in.”
He adds that if an employer passes on its saving to pension scheme members, it can make a salary sacrifice even more appealing to employees, saying: “The recent announcement of increased NI contribution rates from 2022 to 2023 has made salary sacrifice even more attractive over the short-term. There is admittedly less of a benefit for higher-rate taxpayers, due to the lower marginal rate of NI that they pay.”
Communicating to employees
Employers can communicate the scheme’s tax and NI implications, and contribution levels to employees with before and after bespoke payslips to explain the concept and show them the increase in their monthly net take-home pay. One breakdown example is that a worker with annual pensionable pay of £30,000 can make a NI saving on a 5% employee contribution of £15 a month, so their net monthly pay would increase by £15 with no change in the amount of contributions paid.
Dargie states that this can be backed up with employee presentations and frequently asked questions (FAQs). “We have seen some lengthy FAQs which go into a great deal of detail, to the extent that employees might be put off from reading them. Simple online calculators can help employees model the effect of salary sacrifice. It also provides an opportune time to engage and educate employees about the importance of saving for later life. If there are changes to contribution rates themselves, this might require a consultation with employees,” he says.