40% of UK employers aren’t offering salary sacrifice workplace pensions according to Drewberry’s latest Employee Benefits Benchmarking Survey. This means that employers and employees are potentially missing out on big savings due to the tax efficiencies that come from it.
In order to make the most of a salary sacrifice workplace pension (or salary exchange workplace pension), you need to understand what it is it and how it works. So, we’ve put together all you need to know in our complete guide to salary sacrifice workplace pensions below.
A Quick Video On Salary Sacrifice Workplace Pensions
Short on time? Watch our expert video for an overview of workplace pensions and the salary sacrifice method. Our very own, Richard Noble, gives us the lowdown on what salary sacrifice is and how it works when used for a workplace pension scheme. Just press play! 👇
What Is A Salary Sacrifice Workplace Pension?
To understand what a salary sacrifice workplace pension is, we first need to look at traditional workplace pensions.
Workplace pensions were introduced as part of the 2008 pension reforms. New legislation made it a legal obligation for all UK employers to auto-enrol eligible staff into a scheme. This was to help ensure employees were saving towards their retirement.
Net Pay
Although its name suggests otherwise, Net Pay contributions are from an employee’s gross salary, not their net pay. An employee’s gross income is reduced and their tax payments are lower. This method means staff receive tax relief on their pension contributions immediately.
Relief At Source
Through Relief At Source, contributions are from an employee’s salary after tax. These are paid directly to the pension provider, who will then top up the payment by 20%. The provider then claims this 20% back as tax relief from the government.
Being default options, many workplace pensions were set up using the above methods. However, many employers weren’t aware that there was a third option in the form of salary sacrifice.
Salary Sacrifice Workplace Pension
A salary sacrifice workplace pension works in the same way as other employee benefits, such as cycle to work, childcare vouchers, and electric car schemes.
An employee contractually agrees to sacrifice part of their gross salary in exchange for a non-cash benefit. In this case, the benefit is pension contributions. By reducing their overall gross income, employees and employers benefit from tax savings.
What Contributions Can Be Made Via Salary Sacrifice?
The amount an employee sacrifices for their pension pot depends on the scheme. However, by law an employee must contribute 8% of their qualifying earnings (between £6,240 and £50,270). This is the amount earned, including bonuses and overtime, before tax and NI contributions. As an employer you must pay at least 3% of the 8%.
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Employers don’t need to make contributions if an employee is auto-enrolled but decides to opt out of a scheme. However, these employees will need to be re-enrolled every three years.
How Does Sacrifice Workplace Pension Tax Relief Work?
Salary sacrifice workplace pensions can be an attractive option for both employees and employers. This is because of the significant tax relief benefits it offers.
Employee Tax Relief Savings
As an employee agrees to reduce their gross salary in exchange for pension contributions, Income Tax is charged on the lower amount. For example, if an employee earns £30,000 and sacrifices 5% of their salary (£1,500) they will only be charged Income Tax on £28,500.
This means for a basic rate tax payer they would get 20% (£300) tax relief on their £1,500 contribution. Higher tax rate payers would receive 40% tax relief. To help make this clearer, we’ve provided an example below based on a basic rate tax payer.
Salary Sacrifice Tax Relief
No Salary Sacrifice
Salary Sacrifice
Salary Exchange
£0
£1,500
Gross Salary
£30,000
£28,500
Tax (20%)
£3,186
£3,186
Employee NI Contributions
£1,394.40
£1,274.40
Employee Pension Contribution
£1,500
£1,500
Take Home Pay
£23,919.60
£24,039.60
Salary sacrifice is similar to the Net Pay method, in that contributions are taken from an employee’s gross salary. However, the key difference lies in how National Insurance is charged.
With Net Pay an employee will only be charged Income Tax on their gross salary once their pension contribution has been deducted. However, as they don’t contractually agree to lower their salary, they’ll still be charged National Insurance on the full £30,000.
Employer National Insurance Savings
Because employees reduce their gross income, employers also benefit from lower National Insurance (NI). So taking the example above, if an employee reduces their salary from £30,000 to £28,500, as an employer, you would only be charged NI contributions on £28,500.
Employer NI Savings
Employee Salary Sacrifice
£0
£1,500
Employee Gross Salary
£30,000
£28,500
Employer National Insurance
£2,884.20
£2,677.20
Employer Savings
£0
£207
National Insurance Pass Back
As an employer, you have a number of options when it comes to what you do with the savings you make. You can:
Reinvested into the company
Pass 50% back to employees
Pass 100% back to employees
A mix of both.
The savings made can either top up your employee’s pension contributions or boost their take home pay. Passing back these savings on to your employees can provide a really valuable benefit. With the cost of living at an all time high, every little helps.
SMART Salary Sacrifice Vs. Simple Salary Sacrifice
The salary sacrifice arrangements for a pension can either be SMART or Simple.
Simple Salary Sacrifice
Takes the National Insurance savings an employee makes as a result of lowering their gross salary, and adds them to their Net Pay. This means each month employees will take home more money in their pay packet. This is the example we used above under ‘Employee Tax Relief Savings’.
SMART Salary Sacrifice
The SMART option, on the other hand, sees an employee’s pension contributions increase. Rather than the National Insurance savings being added to their net pay, they’re added to their pension contribution.
Example
To help show the difference between Simple and SMART arrangements, we’ve provided an example below.
As in the previous example, we’ve based it on an employee earning £30,000 and choosing to sacrifice 5% (£1,500) in exchange for pension contributions.
Simple Vs SMART
Simple
SMART
Salary Exchange
£1,500
£1,500
Gross Salary
£28,500
£28,500
Tax
£3,186
£3,186
Employee National Insurance
£1,274.40
£1,274.40
Employee National Insurance Savings
£120
£120
Net Pay
£24,039.60
£23,919.60
Employee Pension Contribution
£1,500
£1,620
Most employers opt for a SMART scheme as it supports automatic enrolment. You don’t need prior consent to enrol staff—you do need to communicate their new pension scheme to them, though.
What Are The Advantages Of A Salary Sacrifice Workplace Pension Scheme?
Salary sacrifice workplace pension schemes are becoming increasingly popular among UK employers and employees alike.
They offer a range of benefits that can help employees save for their retirement and improve their financial wellbeing. Not only this, they can offer great savings for both employees and employers.
Advantages For Employers
There are specific advantages for employers that come with switching to a salary sacrifice pension. These can have a significant impact on business performance and culture. We’ve outlined what these are below.
Creates National Insurance (NI) Savings
When it comes to National Insurance, employers are charged contributions based on an employee’s gross salary. With salary sacrifice, as an employee reduces their gross salary, the amount of National Insurance an employer has to pay also reduces.
As mentioned above, this can equate to big savings for employers, which can be:
Reinvested into the company
Passed back to staff to increase their pension fund or take home income, or
A mix of both.
Below is an example of how the potential National Insurance (NI) savings can add up when applied across different numbers of employees. The figures are based on employees earning £30,0000 a year and sacrificing £1,500 (5%) into their pension.
Calculation = (£1,500 x number of employees) X employer NI rate
Employer National Insurance (NI) Savings
Number of Employees
Yearly NI Savings
10
£2,070
20
£4,140
30
£6,210
40
£8,280
50
£10,350
Provides A Valuable Benefit To Employees
Workplace pensions may not be the most exciting employee benefit, but it’s a valuable one. Offering employees a salary sacrifice pension scheme can provide them with a level of financial security.
By investing in their future, you can also show that as a company, you care about them outside of work. This can not only help to retain top talent but also attract it to your business.
Classed As An Allowable Expense
A company can save money through a pension scheme as it’s an allowable expense. The payments have to be for business purposes only, so a pension scheme fits the bill. This means that the employer can enjoy a reduced corporation tax bill.
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Pension contributions are a deductible expense if it is funded under a valid salary or bonus exchange agreement or the contribution is contractual and the same for all staff.
Advantages For Employees
Now for the employee side of things, here are the advantages for your team.
Grows Pension Pot Faster
A salary sacrifice arrangement allows employees to save for their retirement in a tax efficient way. This can help them to grow the value of their pension pot faster, especially if a SMART arrangement is used. The National Insurance savings made can be added directly into an individual’s pension pot.
If as an employee you decide to pass your National Insurance savings back to employees too, this can help employees boost the value of their pension even further.
Pay Less Income Tax And National Insurance (NI)
As the employee sacrifices part of their salary before taxation, they pay less Income Tax and NI. This is because it lowers taxable income. The tax and NI payable by the employee is on the leftover amount after salary sacrifice.
Basic taxpayers (20%) can save up to 32% on NI and income tax. For a higher rate taxpayer, these savings can be up to 22%.
May Increase Take Home Pay
Employees can increase their take home pay through salary sacrifice arrangements. As we said earlier, pre-tax salary deductions reduce income tax and NI payments. As a result, net income is higher without affecting their pension contribution.
Another method of increasing an employee’s net income is via their employer’s NI savings. Giving these to the employee boosts take home pay without adjusting pension contributions.
Common Salary Sacrifice Questions
What Is Salary Sacrifice Vs. Salary Exchange?
Our full definition of pension salary sacrifice is included in this guide. The good news is that salary sacrifice and salary exchange mean the same thing. The terms are often used interchangeably when referring to employee benefits.
Both phrases refer to an employee sacrificing part of their gross monthly salary for non-cash benefits, like a workplace pension.
The employee gives up a percentage of their gross pay and receives a valuable benefit in return. Salary sacrifice offers the employee and employer many benefits, including tax and National Insurance savings.
Is There A Limit To How Much An Employee Can Add To Their Pension Pot?
There are no limits to how much money an employee can add to their pension pot. However, tax relief is only provided on contributions up to £60,000 in a tax year. Exceeding this makes payments ineligible for relief and staff may face a tax charge.
Can Employees Use Salary Sacrifice If On A Low Salary?
This depends on exactly how much you earn. Employees can’t use salary sacrifice if deductions will reduce their net pay to below national living wage. This is against the law and can impact an individual’s living costs.
What Are The Disadvantages Of A Salary Sacrifice Workplace Pension Scheme?
The advantages of salary sacrifice schemes are promising, but there are downsides too. It’s important to understand what these are before implementing one.
Disadvantages For Employers
While there aren’t exactly any disadvantages for employers, there is one thing to consider.
The Amount Of Admin Required
Setting up a workplace pension comes with a significant amount of admin. As salary sacrifice changes an employee’s contract, there are regulations to adhere to.
Employers must automatically enrol their staff in a workplace pension plan. You can postpone enrolment for up to three months, though. You might do this in order to decide which employees you need to enrol. For example, postponement is handy for seasonal or temporary staff.
Another task is ensuring the payroll system is updated and staff get confirmation of the agreement.
A senior staff member needs to be responsible for:
Keeping track of new employees and automatic enrolment legal duties
Evaluating which employees are eligible
Managing requests to join or leave a scheme
Educating staff about salary sacrifice pensions
Updating payroll records accordingly.
The admin can be time-consuming for already busy employers. So it’s important to identify how it’s going to be managed before setting up a scheme. Does your company have the resources to do these tasks? Or do you need to outsource them?
Need Help?
At Drewberry™, our team of financial advisers can help you with the admin and set up if you need extra support.
Setting up a workplace pension scheme includes the following steps:
Choosing a pension provider with automatic enrolment
Identifying which employees are eligible
Informing staff of the scheme and how automatic enrolment works
Declaring compliance with HMRC and the law.
Disadvantages For Employees
Salary sacrifice has many benefits for employees, but there are disadvantages as well.
May Be Counterproductive For Higher Earners
High earners may not be suitable because of tapered annual allowances. This refers to the greatest pension contributions an employee can make each year tax-free. The annual allowance is £60,000 for most people. It includes employee pension contributions, tax relief and employer contributions.
For those earning more than £260,000 a year in adjusted income, the allowance reduces by £1 for every £2 they earn above that. The minimum reduced annual allowance allowed in the current tax year is £10,000.
The annual allowance can lead to unexpected tax bills at the end of the tax year. It can also affect how much an employee can contribute to their pension. If you have higher earners, remember to remind them of the allowance and how it may affect their pension.
Affects How Much Can Be Borrowed
Salary sacrifice lowers an employee’s taxable income. As a result, this can have a knock-on effect when they apply for mortgages, credit cards, or personal loans. Employees may struggle to get any financial help if their gross salary is lower due to their pension contributions.
Credit lenders assess affordability by evaluating someone’s wage after salary sacrifice deductions. So, if an employee is earning less, it could be a barrier when applying for finance. If this is the case, salary sacrifice might not be the most suitable option for some workers.
That said, most lenders will now assess eligibility on their pre-exchanged salary. It’s worth mentioning this to staff as they may be saving for a mortgage deposit or planning to take out a loan.
Can Impact Other Earnings-Related Benefits
Salary sacrifice doesn’t only impact borrowing limits, but other earnings-related benefits, too. If an employee receives life cover, they might receive less coverage due to the salary sacrificed.
But this is dependent on your company and how you manage the salary sacrifice scheme.
Read more!
Things To Consider Before Opting In For Salary Sacrifice
Not all employees meet the criteria for salary sacrifice, so there are a few things to consider first. As the employer, you will also have to consider how practical the scheme is.
For Employers
Here’s what to consider before offering a salary sacrifice scheme:
Will the scheme need extra admin and HR tasks, such as payroll updates?
Who will be responsible for the admin?
What happens to the company’s National Insurance savings? Are they reinvested into the business? Given back to your staff?
How will salary sacrifice affect your other employee benefits?
What are the eligibility rules for workers opting into a salary exchange scheme?
How are you going to track salary sacrifice deductions?
Are there any costs associated with starting a pension for your employees?
Whether The Salary Deductions Will Reduce Take Home Pay To National Minimum Wage
If the salary sacrificed will take an employee’s pay below the national minimum wage, they are not eligible. Due to this, if a full-time worker earns £15,000 or less a year, will not be allowed to be enrolled.
For Employees
For an employee, there’s a lot more to consider, including:
How Salary Sacrifice Will Impact State Benefits
Alongside their pension payments, staff also get a state pension from HMRC. This is based on their NI contributions over time. But as salary sacrifice reduces NI payments, it may impact state pension entitlement.
An employee will get a new state pension if they have paid NI or received eligible credits for ten years. For a full state pension, 35 years of NI payments are necessary.
How Salary Sacrifice Affects Other Employee Benefits
Agreeing to a lower salary through salary sacrifice can affect other benefits.
An example of this is sick pay entitlement. The amount an employee gets may be reduced due to salary sacrifice deductions. It can also affect extended periods of leave and statutory maternity pay.
Earnings that fall below the limit of £6,396 in 2022/23 mean an employee won’t be eligible for:
Statutory sick pay
Statutory maternity pay, paternity pay or adoption leave
Incapacity benefit
Job seeker’s allowance.
If I Apply For A Mortgage, A Loan Or Similar Financial Transaction, What Should I Quote As My Earnings?
It’s recommended to quote your gross pay after salary sacrifice as this is what you will be earning a year. If your net pay remains the same, it will likely not affect your mortgage application. But if your earnings have dropped, lenders might deem you ineligible.
Speak to an independent financial adviser to see where you stand.
Can The Self-Employed Opt Into A Salary Sacrifice Workplace Pension Scheme?
For the self-employed, there isn’t an employer to make a pension contribution on their behalf. This means a self-employed individual can’t use a salary sacrifice arrangement. They can contribute to a personal pension instead.
Should Employees Opt Into A Salary Sacrifice Scheme?
All eligible workers should opt into salary sacrifice schemes to help save for retirement and reap the tax benefits. The advantages we have explained outweigh the disadvantages.
However, employees should only opt in if they can afford it. For example, if they are behind on credit card or personal loan repayments, it’s in their best interests to wait.
The good news is that employees can opt out if they wish. So, if their circumstances aren’t suitable, they can opt out. It’s also worth noting that if they do this, they will have other opportunities to opt back in if they change their mind.
Need Help? Get Salary Sacrifice Workplace Pension Advice
A workplace pension is an essential part of employment. But there’s a lot to consider and many rules and regulations to follow. We know that setting up a pension can be a time-consuming task, so we have a team of financial experts to help you with the process.
If you’re looking to review or set up a new salary sacrifice arrangement, our team can help. We also offer pension advice to individuals to help them better understand what a pension is and how much to contribute.
Get in touch with us today by calling 02074425880 or emailing us at help@drewberry.co.uk.
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