Salary sacrifice and pensions: The lowdown
Maggie Williams, April 20, 2018
Using salary sacrifice agreements as a way to increase pension contributions could be lucrative for both employer and employee
It’s a year since the government reduced the scale of salary sacrificed, or salary exchanged, benefits. Until April 2017 employers were able to offer anything from canteen meals and car parking to iPhones and wine using the tax-efficient scheme.
But now the options are much more limited. Only childcare vouchers, low-emission cars, cycle to work schemes and pension contributions qualify for tax and National Insurance relief under salary exchange rules.
While the reduction in scope might make salary exchange look less attractive, there’s still plenty of advantages to be gained from the remaining benefits – especially pensions. With auto-enrolment minimum payments due to increase this year, salary exchange could be the difference between an employee being able to continue paying into their pension or having to drop out because of affordability.
Under salary exchange rules an employee agrees to a contractual change to give up part of their gross salary for a specified benefit (in this case their pension). Doing so can save employees tax – as the taxable part of their salary is reduced – and National Insurance Contributions (NICs). Employers also benefit from lower NICs as employees are receiving a lower salary.
When auto-enrolment was introduced from 2012, many companies latched onto the benefits that this could offer both their staff and the business. The employer’s NIC savings were often used to soften the cost blow of introducing auto-enrolment in the first instance. When Trader Media Group (TMG) introduced its new pension scheme in 2013 salary sacrifice saved the company an estimated £230,000 in the first year.
TMG used those savings to offer higher employer pension contributions. But there’s no obligation to put the savings back into benefits – employers can simply bank the savings for the business if they wish. “Some businesses look at this as a way of reducing costs and will retain the savings this gives them,” says David Pye, head of client consulting at Broadstone Group. “Others will use it to help with investing in their employees.” That could mean increased pension contributions for staff, investment in other complementary benefits, or improving communications.
With auto-enrolment contributions for both employers and employees set to rise this month and again in April 2019, businesses that aren’t already using pensions salary exchange are beginning to see the appeal. “When auto-enrolment was first introduced there was still some ambiguity about the future of salary exchange,” says Dipa Mistry Kandola, head of flexible benefits services at consultancy LCP. “The recent legislation might have limited the scope of salary exchange in general, but it’s given businesses confidence that the pensions element should be here to stay.”
The benefits of pensions salary exchange might seem clear-cut. However, the notion of ‘exchanging’ or ‘sacrificing’ part of your salary can still be a deterrent if not communicated effectively. “Proper understanding hinges on the quality of communications,” says Phil Farrell, partner at consultancy Quantum Advisory. “People are now more familiar with it, but it still needs to be clearly defined.”Using well-worked examples that show employees how much they could save and explaining the effect this could have on their retirement fund if they choose to use the savings to make extra pension contributions is the most effective method.
Insurance company Thomas Miller introduced pensions salary exchange into its bonus scheme in 2017. This allowed staff to exchange part of their bonus for pension contributions, reducing the amount of tax they would be charged on the lump sum. Grant Lore, group pensions director at Thomas Miller, said that the company worked with its provider Standard Life on a communication strategy. “We had a three-stage action plan, which was tailored to our requirements,” says Lore. This started with a note to all managers at Thomas Miller, explaining the plan and giving them key dates for their staff to take action. The company followed up with a poster campaign advertising details and giving contacts in HR if employees wanted more information. Finally, all staff received a personal email with a link to slides and other information that spelled out the benefits.
As salary exchange effectively lowers an individual’s salary it’s important to make sure staff understand the potential drawbacks as well as benefits. For example, lowering an individual’s salary might affect the amount they can borrow for a mortgage. It’s easy to overcome this, however, by offering employees a letter of reference that they can show to lenders detailing their salary prior to the salary exchange reductions. However, if salary exchange would push an individual’s pay below the national minimum wage it shouldn’t be used – and it’s also worth considering the effect that a reduced salary might have on certain state benefits such as statutory maternity pay.
While there may be some circumstances where pensions salary exchange isn’t the right choice, in most instances it’s a three-way advantage: employees reduce their tax and NICs, employers also reduce their NICs, and if the savings are put back into pensions they can help staff save for a better retirement.