25 April 2023
Employers evaluating their employee benefit packages and considering how to make cost savings should consider using salary sacrifice for workplace pensions contributions if they aren’t already using it. Implementing salary sacrifice for employer pension contributions can still generate National Insurance Contributions (NIC) savings for employers and employees, and the employer NIC savings can be reinvested in benefits available to employees.
What is salary sacrifice for pension contributions?
This is an arrangement where an employee agrees to a reduction in their contractual gross earnings (by an amount equal to their employee pension contributions) and in exchange, the employer agrees to pay increased employer pension contributions instead.
Where implemented correctly salary sacrifice for pensions results in the employer and the employee paying less Class 1 NIC. This is because the employee gives up their right to receive salary (which would otherwise be liable to Class 1 NIC) and receives an employer contribution to a registered pension scheme instead (which is not liable to Class 1 NIC).
Haven’t HMRC stopped this?
No they haven’t. The Optional Remuneration Arrangement (‘OpRA’) legislation introduced on 6 April 2017 removed the tax and employer NIC advantages for many benefits provided under salary sacrifice arrangements.
However, employer pension contributions to registered pension schemes were specifically excluded from the OpRA rules and using salary sacrifice for pension contributions continues to generate NIC savings for employees and employers when implemented correctly.
What are the advantages of salary sacrifice for pension?
The main advantage is the ongoing annual employer and employee Class 1 NIC savings.
An employer has 150 monthly paid employees who each have an annual gross salary of £30,000.
Under the employer’s registered workplace pension scheme, pension contributions are made on annual salary between £6,240 and £50,270 (or the employee’s annual gross salary if lower).
The employer contributes 3% and the employee contributes 5% (including the tax relief added by the government), satisfying the total contributions of 8% currently required under auto-enrolment rules.
The employer does not operate the workplace pension scheme in conjunction with salary sacrifice at present. During the 2023/24 tax year each employee will pay monthly employee’s Class 1 NIC of £174.24 per month for the 9 months between April and December 2023, and £145.20 per month for the three months between January and March 2024 on their monthly salary. The employer pays total monthly employer’s Class 1 NIC of £36,058 on all the employees’ salaries each month too.
If the employer had operated the workplace pension scheme in conjunction with salary sacrifice the employer would pay employer pension contributions of 8% (maintaining the current level of contributions) and the employees would stop making employee contributions. In exchange for the additional employer pension contributions, the employees would accept a reduction of £99 per month to their contractual gross pay. During the 2023/24 tax year each employee would then pay monthly employee’s Class 1 NIC of £162.36 per month for the 9 months between April and December 2023, and £135.30 per month for the three months between January and March 2024 on their reduced monthly salary, and the employer would pay total employer’s Class 1 NIC of £34,009 on all the employees’ salaries each month.
On an annual basis, by utilising salary sacrifice in respect of the workplace pension scheme, the employer would save employer’s Class 1 NIC of £24,588, and each employee would save employee’s Class 1 NIC of £136.62. This example reflects the employee’s Class 1 NIC rate change from 12% to 10% from January 2024.
Although in the example above each employee’s Class 1 NIC savings are modest, the employer could share all or part of the Class 1 employer NIC with the employee by further increasing the company’s employer pension contributions, potentially helping them build a bigger pension fund for their retirement.
Employers who have an annual pay bill of £3m or more and who are subject to the Apprenticeship Levy should note that the Apprenticeship Levy only applies to the total amount of earnings on which an employer is liable to pay Class 1 employer’s NIC. As salary sacrifice will reduce earnings subject to Class 1 employer’s NIC it can also reduce the Apprenticeship Levy paid too.
With the higher rate tax band set at £50,270 and the additional rate of tax now applying to annual income over £125,140, for some employees entering into a salary sacrifice for pensions arrangement could keep the employee’s earnings below these key rate changes. For those who are higher or additional rate payers it also provides the additional tax relief without a further claim needing to be made.
Are there any other considerations?
The employees’ contractual entitlement to earnings must be given up before it is treated as received for income tax and NIC purposes. This means that their contracts of employment must be properly varied before their first reduced salary payment under the new arrangement is made.
The reality must be that the employee is entitled to a lower salary and a non-cash benefit (being the increased employer pension contribution) under the arrangement, and this must be clearly reflected in the supporting documentation.
The salary sacrifice must not reduce employees’ earnings below National Minimum/Living Wage rates which could be a barrier for some employees who are paid at or just above National Minimum/Living Wage rates to participate. For other employees, paid above but close to National Minimum/Living Wage rates, this will need to be carefully monitored.
Employees should consider the wider effect a reduction in their salary can have on, for example, their entitlement to the State Pension, and other contributions-based state benefits, tax credits, and statutory maternity pay. It is best practice for employers to bring this to employees’ attention as part of the implementation process.
How can RSM help?
Our specialists can provide advice on such arrangements and assist you with all aspects of implementation. We can help you ensure that arrangements are implemented efficiently and correctly, assist with the preparation of supporting documentation and employee communications, and seek HMRC confirmation that the salary sacrifice is effective. Finally through our legal team we can also advise on the important employment law implications of such arrangements.