Salary Sacrifice, also known as salary exchange, is a method of paying into a pension scheme. There are other salary sacrifice schemes besides pensions, but they are sometimes treated differently for tax and National Insurance purposes.
Currently salary sacrifice pension schemes are not subject to tax or National Insurance deductions.
What is a Salary Sacrifice Pension?
Simply there is a contractual agreement where an employee agrees to forego a proportion of their salary in exchange for a benefit, in this case pension contributions.
Salary sacrifice pensions can be used in conjunction with auto-enrolment duties, but joining a salary sacrifice scheme cannot be mandatory. It is not straightforward using salary sacrifice for auto-enrolment, and we recommend seeking advice, there also is further guidance available from The Pension Regulator.
Using Salary Sacrifice Pensions
There are some concepts that people seem to initially struggle with when adopting a salary sacrifice pension scheme:
- The salary is reduced. The pension is treated as a ‘benefit’
- The contributions are now 100% from the employer. The employer is providing the ‘benefit’
A salary sacrifice pension scheme usually requires more work to set up, but is made attractive by the National Insurance savings available. Because of confusion between terms we sometimes have net pay arrangements described as salary sacrifice schemes, but as can be seen they are different.
For higher rate taxpayers the contributions have not had tax deducted, and so full tax relief has already been applied. This is similar to a pension scheme under a net pay arrangement.
As with other methods of pension deductions it is essential that payroll know if a pension scheme is to be set up as a salary sacrifice, and what pay types are considered to be pensionable.
The NIC saving
Consider an employee on £30 000pa, 1100L tax code and NI category A, they have agreed to sacrifice £50 of monthly salary, and the employer will match the contribution. Shown with and without the salary sacrifice.
The employee net salary does not reduce by the full £50 as they also pay less tax and National Insurance. There is an employer’s National Insurance saving and this can be treated in different ways.
Some employers will pay the full NIC saving into their employee’s pension, in the example above this would be £7, and others will keep the saving towards the cost of the scheme, or share a proportion with the employee.
The employee NIC saving is already reflected in their net pay.
Salary Sacrifice Pensions for low paid workers
Generally this is not a good option and should be treated with caution. If the worker does not earn above the NIC thresholds then there will be no saving, and the salary after the sacrifice must not be below the National Minimum Wage or Living Wage as appropriate.
Disadvantages of the Salary Sacrifice Pensions
There are disadvantages and these should be considered. Several are centred on the simple fact that the salary has been reduced, and this can have an impact on items such as mortgages, to SMP payments.
The employer also needs to consider that they will be providing a benefit to their employees, which will be treated differently to salary.
Seek advice before launching a salary sacrifice pension scheme – this appears to be the most complex method of making pension deductions.