Checklist

Using a salary sacrifice arrangement with the employer can be a tax-efficient way to generate pension contributions. There are two methods used to make the most of tax and National Insurance paid: either increase the member's take-home pay or increase the member's pension contribution. These are outlined below:  

Increase take-home pay

This method allows the employee to maintain their current pension contribution and increase their take-home pay by sacrificing some of their salary.  The National Insurance saving from sacrificing some of the salary is added to the take-home pay.

Increase pension contribution

This method allows the employee to maintain the same level of take-home pay and increase the pension contribution by sacrificing some of their salary. The National Insurance saving from sacrificing some of the salary is added to the pension contribution.

Putting the salary sacrifice arrangement in place involves several steps that could involve many parties including the employer, their payroll provider, their financial adviser, the employees and the pension provider chosen to administer the scheme. It’s imperative that a suitable process is followed so that the salary sacrifice is clearly documented and that the resulting contributions are correctly applied to the pension scheme. As a guide, here’s a brief checklist highlighting the main steps and issues to take account of:

Initial decision

One of the first steps in the process is for the employer to decide that they want to offer salary sacrifice. Following on from that, a decision will need to be made on how to apply the employee's National Insurance savings and how much of the employer's National Insurance savings will be added (if any) to help boost the pension contributions or take-home pay post sacrifice. Remember, an employee can only sacrifice future earnings, which can either be regular earnings or a contractual bonus that has yet to be received.

Employee discussions

The employer may want to hold an initial informal discussion with the employees to explain how salary sacrifice works and the benefits of using it for pension contributions. They are also likely to prepare salary sacrifice literature for employees to aid their understanding. The literature may include additional information relating to opting out of salary sacrifice when a lifestyle event occurs, the employer using a notional salary for other employee benefits, and the effect on State benefits that a reduction in gross salary may have.

Identifying suitable employees

It’s worth pointing out that HMRC guidance confirms a salary sacrifice arrangement can’t reduce an employee’s gross earnings below National Minimum or Living Wage rates, so salary sacrifice won’t be suitable for these employees.  In addition, where employees earn less than the personal allowance, salary sacrifice will only result in an increased pension contribution where around 75% of the employer’s National Insurance saving is passed on to boost the pension contribution. 

At the other end of the pay scale, consideration needs to be given to higher earners who may be subject to the tapered annual allowance or who could be if they agree to the salary sacrifice arrangement.

Compare options 

Using the pre-sacrifice salary and pension contributions, estimate what National Insurance savings could be made and where that saving should apply; to pay or to pension contribution. Note: remember to consider where in the United Kingdom employees are taxed.

Document the options clearly so the employee can understand the changes to their benefits.

Employee agreement and change of contract

Making a change to the employee's salary will require their agreement.  Clear documentation outlining the changes to salary is essential, and that the employee is agreeing both to opt in to the salary sacrifice and to the change in their terms and conditions.

Confirmation of sacrifice

For employees that have agreed to use salary sacrifice, the employer should then communicate details of the changes that will apply to each employee and take steps to adjust PAYE records to ensure the correct salaries will be used post sacrifice. If the outcome of the salary sacrifice is that only employer contributions are paid after sacrifice, then there should be no employee contributions deducted from an employees pay after the sacrifice has been implemented.

Is the sacrifice effective?

Returning to the HMRC guidance referred to earlier, it’s possible for an employer to ask HMRC (Clearances Team) to confirm that a salary sacrifice arrangement is effective once it is in place.

Pension contributions and tax relief

As a reminder, pension tax relief on employee contributions is given in different ways, depending on the type of pension scheme the employer operates, and whether or not salary sacrifice is being operated.

Salary sacrifice not being operated 
There are generally two ways to include tax relief when an employee pays their own contributions; Relief at source and Net pay (refer to HMRC guidelines for more information).

Relief at source 
This method of tax relief is used where the employee pension contribution is deducted from net pay. The pension scheme administrator claims basic rate tax relief from HMRC and adds it to the net contribution. Personal pension schemes run on this basis.

Net pay 
Using this method of tax relief means that pension contributions are deducted from pay before PAYE tax is calculated and deducted. This means the employee receives tax relief up front and the gross contribution is passed to the pension scheme. No additional tax relief is claimed from HMRC by the pension scheme administrator. Occupational pension schemes operate on this basis.

Salary sacrifice being operated 
Once salary sacrifice has been agreed between the employee and employer, the employee pension contribution is altered to the employer contribution. No tax relief is therefore required when salary sacrifice is being used as the employee is receiving less pay in return for the pension contribution being paid by the employer. The scheme administrator must be informed where employers are using salary sacrifice so that they apply contributions correctly and do not claim tax relief from HMRC.

An increased employer contribution from a salary or bonus sacrifice arrangement will normally be treated as being wholly and exclusively for the purposes of trade and allowable as a deduction when calculating an employer’s taxable profits. Please refer to the Employer contributions guide.

Passing contributions to the provider

It’s important to make sure that the correct contribution details are given to the pension scheme administrator when contributions are paid post sacrifice so that the pension provider knows the type of contribution being made - employee, employer or salary sacrifice (employer) - and whether tax relief should be added or not.  Any inaccuracies could result in the wrong type of contributions being applied and lead to tax relief incorrectly being claimed from HMRC, which will have to be repaid once the inaccuracy is discovered.

Future reviews

Once a salary sacrifice arrangement is in place for a pension scheme, the employer can then offer new employees the option of joining the scheme on a salary sacrifice basis. If necessary, this can be run in parallel with any automatic enrolment duties that an employer may have.

On an ongoing basis, an employer offering salary sacrifice may want to review existing calculations regularly (for example, where salaries are increased on an annual basis).

Salary sacrifice isn’t an easy concept to get to grips with. However, adopting and following a set process when introducing a salary sacrifice arrangement should help ensure that it is implemented correctly with the benefits (and possible implications) of doing so being clear to both employers and employees.