Pensions auto-enrolment is one of the most important developments for employers currently coming into effect. Businesses with fewer than 50 employees must implement the process from 1 June 2015. As a consequence, employers will be looking to maximise tax reliefs, while employees will also seek to join the scheme in the most cost-efficient manner possible. A salary sacrifice arrangement will be an attractive option to consider in achieving both goals.
From October 2018 the minimum contributions payable by the employer and employee rise to 3% and 5% respectively. An employer may wish to run a salary sacrifice arrangement alongside their other auto-enrolment provisions.
What is salary sacrifice?
Salary sacrifice arrangements involve a contractual right to one’s cash pay being reduced. When drawing up such an arrangement the potential for future remuneration must be given up, and the new contract must state that the employee is entitled to lower cash and a benefit instead.
Under auto enrolment, salary sacrifice arrangements can be used to meet the full 8% contribution. It is essential that membership of the pension scheme can be achieved without the employee having to consent to the salary sacrifice arrangement in advance, and it is crucial that payment options are allowed other than salary sacrifice.
What’s the advantage?
Both the employer and employee save money because there are reductions in the individual’s gross pay in exchange for the pension contribution by the employer which is tax and NIC free. Therefore there are savings on:
- the employee’s NIC payable on the salary sacrificed of up to 12% and
- the employer’s NIC payable on the salary sacrificed of 13.8%.
There is no tax saving as the tax saved is cancelled out by the tax relief from HMRC that would have been available on the employee’s contribution.
An employee has a salary of £30,000 and surrenders the right to £1,500 (5%) salary in exchange for the employer making a pension contribution of the same amount. Using 2014/15 rates, the new salary is £28,500 with net pay of £22,335. The NIC saving is £180 (£1,500 x 12%). The employer saves 13.8% on the reduced salary of £207.
If there were no such arrangement, the employee has a lower net pay of £22,155 after £1,200 pension contributions are deducted from net pay. This would be topped up by HMRC with tax relief of £300 so that £1,500 goes into the pension scheme.
A salary sacrifice arrangement cannot reduce an employee’s cash earnings below the National Minimum Wage.
Considerations for employees
Employees must consider the impact a reduction in pay could have on their personal finances. In particular, entitlement to state benefits such as Statutory Maternity Pay is affected.
If you need more advice with pensions auto-enrolment, or implementing salary sacrifice schemes, please contact us.