Salary sacrifice pension arrangements are a way for employers to enhance employee take home pay or pension contributions, largely because they are efficient for National Insurance Contributions (NICs).

However, RSM’s Fair Pay team is increasingly seeing pension arrangements inadvertently creating a National Minimum Wage (NMW) compliance risk, all because of the way payroll is implementing them, even if they seem correct on the face of it. This situation can lead to significant historical liabilities, alongside the financial and reputational risks associated with HMRC enforcement of NMW breaches.

This risk is separate from the more common errors relating to whether salary sacrifice arrangements have been implemented effectively for tax and NIC purposes.

How pension salary sacrifice affects National Minimum Wage pay

With a salary sacrifice arrangement, an employee agrees to reduce part of their gross salary in exchange for an employer pension contribution of an equivalent amount. Crucially for NMW purposes, this sacrificed salary is treated as a reduction in taxable and NIC-able pay. As such, an employee’s post sacrifice pay (reduced pay) must not fall below applicable NMW or National Living Wage thresholds.

While many employers are aware of this rule, there can be issues where payroll systems don’t flag when a salary sacrifice reduction causes a breach of NMW thresholds. In practice, NMW compliance is a complex area as it depends on identifying the relevant NMW work type and applying the right calculation methodology, which includes making sure the correct pay elements are included within that calculation. Without doing this groundwork, the correct NMW check can’t happen.

Crucially, outsourcing payroll, even to well established providers, does not remove this risk. While providers may operate robust systems, they will typically rely on the instructions, information and/or parameters employers provide. If there are gaps in that information or the check hasn’t been tailored to the circumstances and facts of the employer’s worker population, the payroll provider is unlikely to apply the correct calculation.

Ultimately, the employer is responsible for NMW compliance and making sure that appropriate checks, controls and oversight remain in place internally, even where payroll is fully outsourced.

Common pension salary sacrifice errors causing NMW breaches

The common scenarios where we see this risk include:

• Fixed percentage pension contributions are applied even when earnings fluctuate (eg due to reduced hours or overtime).
• Salary sacrifice calculations incorrectly include or exclude pay elements because the employee has been assigned the incorrect NMW work type.
• Checks are only carried out when a salary sacrifice is selected, rather than on a pay period by pay period basis.
• Overrides or manual adjustments may bypass built in payroll safeguards.
• Poor integration and/or communication between HR (eg working hours) and payroll systems mean information isn’t reflected.
• Other salary sacrifice arrangements may interact with the pension contributions and affect the calculations.

How the Fair Work Agency will increase NMW enforcement

The new Fair Work Agency (FWA) is now in place and will be responsible for detecting and enforcing NMW errors from April 2027.

As it will bring together several enforcement bodies, it is expected to be more coordinated and proactive in labour market enforcement, including NMW compliance. Essentially, it will be better at spotting and acting on NMW issues.

Here’s what we can expect:

• Greater enforcement powers: the FWA will have more authority to investigate employers and enforce compliance.
• Increased focus on NMW: HMRC already actively reviews NMW, and this scrutiny will intensify under the new regime.
• Financial penalties: employers can face penalties of up to 200% of the arrears, subject to a cap per worker (although, in practice, penalties are generally reduced to 100% when paid promptly).
• Naming and shaming: non compliant employers may be publicly listed, creating reputational risk.
• Cost of enforcement: in addition to arrears and penalties, employers may incur costs associated with investigations, remediation exercises and professional support.

Employers should be aware of record keeping requirements. Records relevant to NMW compliance must be kept for up to six years, increasing the importance of maintaining accurate and auditable payroll data. This includes details of hours worked, pay elements and salary sacrifice arrangements, all of which may be scrutinised as part of any HMRC or future FWA review.

How employers can reduce pension salary sacrifice NMW risk

As enforcement activity increases and regulatory expectations evolve, employers should take the opportunity to review their salary sacrifice arrangements, together with the associated payroll controls and processes. This exercise will help ensure that potential NMW risks are identified and addressed before they become costly compliance issues.

With the support of our Fair Pay team, we can:

• Review payroll system controls.
• Carry out a sample review of cases for at risk groups.
• Provide education and training for HR, payroll and operations teams to equip employers to monitor ongoing compliance.
• Help correct historical issues and liaise with HMRC.

If you would like us to assess whether your pension salary sacrifice arrangements could be creating NMW risks, or need support reviewing payroll controls and compliance processes, please get in touch with Chris Robson or your usual RSM contact.

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