Salary sacrifice pensions

Lucy Brewitt discusses the beneficial role salary sacrifice pensions can play for employees, as well as some of the issues they can cause if administered without enough forethought.

A salary sacrifice pension serves two purposes for a staff member. The first is that it can enable them to top up their pension pot quickly. The second is that it can be very tax efficient; even though it is called a ‘salary sacrifice’ pension, it can actually result in an increase in take-home pay.

It is not currently the most popular way in which people contribute to a pension: the government-introduced auto enrolment pension scheme enables an employer to help staff with their retirement by providing extra contributions over and above what comes out of their employee’s pay packet. This is the usual route today that staff will take, allowing them to sign up and then give the issue little thought on their part.

But we know it is important to make sure everyone is properly prepared for retirement, based on individual circumstances, and that can mean one way of saving for a pension does not work for all. At the same time, we appreciate that people are often seeking savvy ways to not only boost later-life income but the money they are currently getting each month.

One answer is a salary sacrifice pension – something that can help the employer as well as the employee.

What is a salary sacrifice pension scheme?

The way it works is an employee gives up a chunk of their annual pay. This can be a salary or another element of their income, like a bonus. The person giving this money up agrees for it to be added by the employer, as a benefit in kind, into their pension pot. In many situations, how much money is “sacrificed” is decided by that member of staff, but some businesses have put their own rules in place for this scenario.

Two things immediately happen when this pension payment method is put into action. First, the staff member’s taxable income drops, so they will see a reduction in both tax and NI contributions. This also means that full tax relief is given through salary, thus removing the need for higher earners to apply for higher rate tax relief via self-assessment. The second is that, for the same reason, the business also pays less National Insurance for employing that person.

Often, the employer will take that saving in National Insurance and add that to the staff member’s pension pot as well however this at the employer’s discretion.

How this works with a business’s other pension schemes

Salary sacrifice can work with whatever pension schemes your organisation has in place. So, there is little need to make any major changes or additions to the benefits you already offer to staff. The main thing is to ensure your business tells the pension providers which staff members are signed up to your salary sacrifice scheme. What percentage of money is paid on behalf of the staff to the pension provider by your business is decided between yourself and the employee – the pension provider plays no real role in that part of the arrangement.

What we can see is that salary sacrifice can work with existing pensions and that many can benefit from such an arrangement. However, there are some pitfalls.

The drawbacks of a salary sacrifice scheme

The price of good tax efficiencies is eternal vigilance, and salary sacrifice pensions are no exception to the rule.

First, there is the danger of taking a staff member’s pay below the National Minimum Wage. A miscalculation of pay or hours could mean that the staff member sees their money drop below this important legal threshold. If staff wages drop below this level, it is incumbent on a business to pay that money back. Unchecked, over time, this can accumulate to quite a financial hit for the business in question.

Partly, this is because the company must repay the shortfall, but also it is because any money paid cannot be reimbursed. It has been paid into that pension by the business and is effectively non-refundable. If there are second thoughts on the part of the business or the employee about a salary sacrifice pension scheme, some damage may well be done after month one.

Clearly, a business may suffer because of poorly thought-out salary sacrifice pensions, but an employee can have problems as well. Whereas the employee might see an increase in their take-home pay, benefits like life insurance may have problems as they are tied to a salary, not take-home pay. Statutory sick pay and maternity pay may also be affected by lowered earnings. In fact, the government says people run the risk of losing such pay altogether if enough care is not given to a salary sacrifice pension.

Employers need to remember, meanwhile, that  both their contribution and the salary sacrifice contribution needs to be based on full salary, even if that person takes time off to raise a newborn.

And, of course, borrowing is often tied to a salary. For instance, if a staff member has their eyes set on a new house, then the salary number becomes crucial when applying for a mortgage.

Important things to remember

The important thing is to put the right contract in place: a priority for your human resources team. What exactly is being sacrificed? For most people it is their annual salary, but for others it could be another element of pay, such as a bonus. This will determine the nature of the contract – it could be a one-off or it could need to be an addition to the employee’s contract which renews each year depending on what is being given up.

The government also urges businesses to set a notional level of pay in place, safeguarding the employee and the business from a situation where the money will drop below National Minimum Wage.

Make sure you can keep up

This type of pension arrangement is difficult to administer. It needs constant vigilance and a joined-up way of working which can allow you to oversee things from a financial and legal standpoint – for your business and your staff.

This is why many businesses, non-profits and charities turn to a partner to help them oversee payroll. Dataplan acts for thousands of organisations across the UK, managing the wages and benefits for companies of all sizes. Dealing with a variety of pension schemes is second nature to our team of payroll heroes.

Contact us to discover how we can help you with salary sacrifice pensions.

Written by Lucy Brewitt
Published on November 1, 2022

Dataplan are one of the UK’s leading providers of specialist payroll and associated services.

From payroll outsourcing and pension service management to ePayslips and gender pay gap reporting; we have a solution for you and your business.