Why could salary sacrifice not be suitable for everyone?

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For employers only

One of the key points made in HM Revenue & Customs salary sacrifice guidance is that a salary sacrifice arrangement must not reduce an employee’s cash earnings below National Minimum Wage (NMW) rates.

In practical terms, employers must put procedures in place to cap salary sacrifice deduction and ensure NMW rates are maintained with the basic point being that an employee must have earnings after sacrifice that are still above the NMW rates.

Another separate but linked point, is that salary sacrifice may not be suitable or may only show minimal benefit for employees with low earnings. In particular, this is likely to affect part-time workers who after sacrifice, still earn above the NMW rate, but who don’t earn enough due to the part-time nature of their employment to pay income tax.

The reason for this is that salary sacrifice uses the income tax and National Insurance (NI) savings generated by an employee’s gross salary reducing as part of the sacrifice to help increase the pension contribution or take-home pay after sacrifice.

If an employee’s gross salary is near the income tax and NI thresholds, then there may be little or no savings to add in to make the salary sacrifice effective.

Depending on the type of salary sacrifice quote being created, you could see quotes where either the pension contribution, or take-home pay reduces, after sacrifice as the following examples show.

Keep net income (take-home pay) constant

This example is based on a part-time employee earning £10,000 each year with a 5% gross employee contribution and a 3% employer pension contribution before sacrifice.

  Before sacrifice After sacrifice
    50% employer NI saving added in 75% employer NI saving added in 100% employer NI saving added in
Gross earnings £10,000 £9,545.45 £9,545.45 £9,545.45
Personal allowance £12,500 £12,500 £12,500 £12,500
Amount liable to tax £0 £0 £0 £0
Income tax (including tax relief) -£100 (tax relief) £0 £0 £0
Employee NI £164.16 £109.61 £109.61 £109.61
Gross earnings less tax & NI £9,935.84 £9,435.84 £9,435.84 £9,435.84
Gross employee pension contribution £500 £0 £0 £0
Take-home pay £9,435.84 £9,435.84 £9,435.84 £9,435.84
Employer NI £188.78 £126.05 £126.05 £126.05
Total gross pension contribution £800 (£500 employee and £300 employer) £785.92 employer £801.60 employer £817.28 employer
Cost to employer £10,488.78 £10457.42 £10,473.10 £10,488.78

These figures help show that the total gross pension contribution will:

  • Reduce after sacrifice if 50% or less of the employer NI saving is added to the pension contribution as part of the sacrifice. This means that the employer pension contribution after sacrifice will be lower than the total gross employee and employer contribution before sacrifice.
  • Increase after sacrifice if 75% or more of the employer NI saving is added to the pension contribution as part of the sacrifice. This means that the employer pension contribution after sacrifice will be marginally higher than the total gross employee and employer contribution before sacrifice.

Keep pension contributions constant

This example is based on a part-time employee earning £10,000 pa with a 5% gross employee contribution and a 3% employer pension contribution before sacrifice.

  Before sacrifice After sacrifice
    50% employer NI saving added in 75% employer NI saving added in 100% employer NI saving added in
Gross earnings £10,000 £9,532.27 £9,546.90 £9,560.63
Personal allowance £12,500 £12,500 £12,500 £12,500
Amount liable to tax £0 £0 £0 £0
Income tax (including tax relief) -£100 (tax relief) £0 £0 £0
Employee NI £164.16 £108.03 £109.79 £111.43
Gross earnings less tax & NI £9,935.84 £9,424.24 £9,437.11 £9,449.20
Gross employee pension contribution £500 £0 £0 £0
Take-home pay £9,435.84 £9,424.24 £9,437.11 £9,449.20
Employer NI £188.78 £124.24 £126.26 £128.15
Total gross pension contribution £800 (£500 employee and £300 employer) £800 employer £800 employer £800 employer
Cost to employer £10,488.78 £10,456.51 £10,473.16 £10,488.78

These figures help show that take-home pay will:

  • Reduce after sacrifice if 50% or less of the employer NI saving is added to take-home pay as part of the sacrifice. This means that take-home pay after sacrifice will be lower than take-home pay before sacrifice.
  • Increase after sacrifice if 75% or more of the employer NI saving is added to take-home pay as part of the sacrifice. This means that take-home pay after sacrifice will be marginally higher than take-home pay before sacrifice.

Summary

These two examples highlight that for employees with salaries near the income tax and NI thresholds, there may be little or no savings to add in to make the salary sacrifice effective.

Care therefore needs to be taken to make sure that any quotes produced for these employees will be effective in achieving the aim of:

  • keeping take-home pay the same and increasing the pension contributions after sacrifice, or
  • keeping the pension contributions the same and increasing take-home pay after sacrifice.

The information in this article is based on our understanding of current, taxation law and HMRC practice, which may change.