Can salary sacrifice be used for pension contributions?
Salary sacrifice, or salary exchange as it is often called today, in the simplest terms is an arrangement where an employee agrees to receive less pay in cash, instead choosing to take a non-cash benefit instead. Salary sacrifice can be attractive from both an employee and an employer’s point of view because it can be a great way to legitimately reduce tax and National Insurance Contributions.
Making a pension contribution for an employee is a good example of a non-cash benefit being paid in lieu of cash. So, in broad terms; yes, salary sacrifice can be used for pension contributions. However, what is important when it comes to automatic enrolment and salary sacrifice is that there must be choice for the employee.
The way salary sacrifice works is that the employer needs to make a legally enforceable change to the employee’s terms and conditions that will reduce their pay accordingly. When they have done this, the employer then seeks agreement from the HMRC Clearances Team to confirm the impact that the change will have on tax and National Insurance Contributions. Only by following these steps is salary sacrifice officially approved.
One thing that is worth bearing in mind is that salary sacrifice can’t be used to reduce any employee’s income to below the National Minimum Wage.
Although the advantages of salary sacrifice for employers and employees alike is obvious for all to see, it is not an arrangement that suits everyone. Because of this, as an employer you would need to explore the opportunities with your employee before assuming that it will be possible to use salary sacrifice for pension contributions.
How salary sacrifice works in conjunction with auto enrolment
As an employer, it’s your role, when your staging date comes along to enroll all eligible job holders into a suitable pension scheme. You must do this whether they want to be enrolled or not. Should they decide that they don’t want to be part of the pension scheme, they will subsequently have the right to opt out.
When it comes to salary exchange or salary sacrifice, you can’t make such an assumption for the employee. You must give the employee the choice as to whether they want to accept a salary exchange or sacrifice arrangement. This is particularly important when it comes to auto enrolment because anyone who opted out of auto enrolment under a salary sacrifice arrangement could find themselves in a situation whereby the salary sacrifice arrangement becomes null and void because it normally needs to be in place for at least a year to qualify.
Although there are certain allowable “lifestyle events” which allow salary sacrifice arrangements to be broken, auto enrolment opt-out isn’t currently deemed to be such, so beware.
If between you and your employee you decide that £300 of pension contributions are going to be funded by way of salary sacrifice, then the employee’s pay will reduce by £3,600 per year. In this instance, both the employer and the employee will save on their relevant National Insurance Contributions and the employee will save on income tax.
So, in summary, while as an employer you can’t insist that your employee accepts salary sacrifice in return for pension contributions, you can give them the choice.
If you’re an employer who’d like to explore in more detail the possibility of availing of salary sacrifice or salary exchange opportunities in your business, why not get in touch? We can help you make sure that you stay firmly on the right side of auto enrolment legislation at the same time as maximising your cost saving possibilities.