This guide is for financial advisers only. It mustn’t be distributed to, or relied on by, customers. It is based on our understanding of legislation as at May 2023.
One of the outcomes of a salary sacrifice arrangement can be to help generate pension contributions for employees. Many providers offer a salary sacrifice calculator to help with the calculations and Aegon has an individual salary sacrifice calculator for individual quotes and a bulk spreadsheet for multiple quotes. These offer the following quote options:
The field Convert tax and NI savings will be one of the following:
- To pension – allows an employee to maintain the same take-home pay and increase their pension contribution by sacrificing some of their salary.
- To pay – allows an employee to maintain their current pension contribution and increase their take-home pay by sacrificing some of their salary.
- Both – allows an employee to increase both their take-home pay and pension contribution by sacrificing some of their salary.
The instruction under SALTYPE with be either TYPE 1 or TYPE 2 depending on the option required:
TYPE 1: Keep pension contributions constant (KPCC) – allows an employee to maintain their current pension contribution and increase their take-home pay by sacrificing some or their salary. The employee contribution before sacrifice changes to an employer contribution after sacrifice.
TYPE 2: Keep net income constant (KNIC) – allows an employee to maintain the same take-home pay and increase their pension contribution by sacrificing some of their salary. The employee contribution before sacrifice changes to a higher employer contribution after sacrifice.
The main difference between the two options is that for the Keep net income constant option the employee national insurance saving is added to the pension contribution after sacrifice whereas for the Keep pension contributions constant option it is added to the take-home pay after sacrifice.
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 provider’s pension scheme. As a guide, here’s a brief checklist highlighting the main steps and issues to take account of:
One of the first steps in the process could be for the employer to decide that they want to offer salary sacrifice. Following on from that a decision will need to be made on which quote option to use and how much of the employers’ National Insurance (NI) 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.
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. Note: Aegon’s calculator does not cater for employees who don’t pay tax.
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.
Quotes can be produced from a salary sacrifice calculator tailored to the requirements the employer wants to use for their salary sacrifice arrangement. Quote inputs will typically ask for the quote option, the pre-sacrifice salary and pension contributions plus how much of their NI saving the employer is adding in. There may also be questions asking if the employee is an apprentice or a Scottish taxpayer to make sure the relevant tax and NI rates and bands are used.
Check quote outputs
The output from a salary sacrifice quote will vary depending on the pre-sacrifice salary and pension contributions, the type of quote requested and the employer NI savings being added. So, it’s important to do a sense-check of each quote after it’s been produced to make sure it is in line with the intended quote basis and the details that were input.
Employee agreement and change of contract
The quote output will include a copy of the quote and may have the option of producing a covering letter for the employee confirming the details of the salary sacrifice. The covering letter produced from Aegon’s bulk salary sacrifice spreadsheet allows it to be used to provide a sign-off for the salary sacrifice. This is done by employees agreeing both to opt-in to the salary sacrifice and to the change in their terms and conditions. The quote output from Aegon’s individual salary sacrifice calculator doesn’t include wording for an employee sign-off – the employer would need to draft their own agreement.
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 or 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.
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 and tax relief FAQ.
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.
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.