Salary sacrifice and Auto Enrolment

Salary sacrifice and Auto Enrolment

With pension auto enrolment applying to more and more employers, we look at the options for using a salary sacrifice scheme to deliver tax savings for the employer and the employee.

Salary sacrifice takes place when an employee gives up the right to part of their remuneration in return for the employer providing the employee with some form of non-cash benefit.

As announced in the 2016 Budget, the government is considering limiting the range of benefits that attract income tax and National Insurance advantages when they are provided as part of a salary sacrifice arrangement. However, the government's intention is that pension savings, childcare and health related benefits will continue to attract these reliefs. One option therefore is that employees sacrifice part of their salary in return for the employer paying a sum to a registered pension scheme for the employee's benefit.

Conditions for effective salary sacrifice

The recent Reed Employment tax case illustrated that it can be costly to implement a salary sacrifice scheme incorrectly. To be effective the arrangement has to reduce the employee's contractual right to cash remuneration. This requires two conditions to be met:

  1. the employment contract must be effectively varied before the changes are implemented ie the employee must give up their salary before they are entitled to receive the remuneration and
  2. the revised contractual arrangement must show that the employee is entitled to lower cash remuneration and a benefit.

In addition, the employee should not have the right to give up the non-cash benefit and revert to the higher cash salary within 12 months.

In practice, the variation of the contract can be achieved by rewriting the contract, setting out the changes in a separate document attached to the contract or by giving employees an 'opt out' option. An 'opt out' clause would specify a time limit by which time employees would have to opt out of the salary sacrifice arrangement. Failure to do so would be regarded as an 'opt in'. Employees would need to be fully informed of the proposals.

It should be noted that the cash wage cannot fall below rates set in the National Minimum Wage and the National Living Wage following salary sacrifice. Salary sacrifice can affect an employee's entitlement to certain state benefits such as Maternity Allowance and Incapacity Benefit. Therefore consideration should be given to excluding lower paid employees from the scheme.

Effects of successful salary sacrifice

Where salary sacrifice is implemented with a pension payment being provided by the employer then the employee will pay income tax and NICs on the lower cash salary. There is no charge to income tax or NICs on the amount of the pension payment made by the employer.

The effect of using salary sacrifice for employee's pension payments would therefore be a saving of up to 12% for the employee and up to 13.8% for the employer.

Example

Using a salary of £30,000 and 2016/2017 tax rates. An employer contribution of 2%, employee contribution 4% before tax relief.

 

Before

After

Employee's net pay

Salary

PAYE

Employee NIC

Pension contribution (net of tax relief)

Net pay

£

30,000

(3,800)

(2,633)

(960)

22,607

£

28,800

(3,560)

(2,489)

NIL

22,751

Employer's costs

Salary

Employer's NIC

Employer's pension contribution

Total cost to employer

£

30,000

3,021

600

33,621

£

28,800

2,855

1,800

33,455

Total pension contribution

1,800

1,800

The employee's net pay would increase by £144 and the cost to the employer would fall by £166.

HMRC approval

HMRC will not comment or advise on any proposed salary sacrifice arrangements as they do not want to be involved in employment agreements. They will, however, give assurance after the arrangements are in force. To allow HMRC to do this they will require sight of all relevant documentation.

The requirements of salary sacrifice schemes can be complex and if you need any further advice do not hesitate to get in touch.

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