Beware of national minimum wage risks when using salary sacrifice

As the dust continues to settle following a first Labour government Budget in 14 years, employers should be considering their options as labour costs look set to rise from April 2025.

From 1 April 2025, national minimum wage (NMW) rates will increase by between 6.7% and 18%, with the national living wage being set at £12.21 per hour, whilst employers National Insurance contributions (NICs) are also set to rise from 13.8% to 15% on earnings above the NICs secondary threshold. Neither of those changes were unexpected, but the Chancellor’s announcement lowering the NICs threshold from £9,100 to £5,000 drew a sharp intake of breath.

Various approaches will need to be considered by employers in order to manage these additional costs. Some may have no choice but to pass them on to customers and clients in the form of higher prices. Others may look to find savings, which may mean revisiting pay and reward plans for the next financial year or, in a worst-case scenario, introducing hiring freezes and job cuts.

Pension salary sacrifice

There are few easy wins following the Autumn Budget, but salary sacrifice may be one option worth considering. A salary sacrifice arrangement involves an employee agreeing to a reduction in their cash pay in return for a non-cash benefit. Common examples include pension contributions, cycle to work schemes and holiday purchase.

Pension salary sacrifice arrangements can be beneficial for several reasons.

• They may be tax efficient - by reducing salary, employees lower their taxable income, which can result in paying less income tax and employee NICs. 
• Employee income may be reduced below the relevant thresholds for child benefit or tax-free childcare. 
• The amount of salary that the employee sacrifices may be paid into their pension, boosting retirement savings.
• Employers also save on NICs, and this saving can sometimes be passed back or shared with employees in the form of higher pension contributions or other benefits.

Even where employers already have an optional salary sacrifice for pensions in place, it may be worth considering how to increase the take up. 

With employer NICs increasing to 15%, the benefits of salary sacrifice arrangements have increased due to the additional savings the employer can make. Salary sacrifice arrangements need to be set up properly though, in accordance with HMRC guidance. Common mistakes include failing to ensure there is a valid variation of the employment contract (a necessary condition of any valid salary sacrifice arrangement), and introducing salary sacrifice for a benefit which must still be treated as taxable and subject to class 1 NICs. It is therefore crucial to ensure that salary sacrifice arrangements are reviewed to ensure compliance and tax efficiency. 

Impact of salary sacrifice on national minimum wage compliance

The increased use of salary sacrifice brings into focus its impact on NMW. As salary sacrifice arrangements reduce participating employees’ cash pay, it is the post-salary sacrifice amounts which must be taken into account when considering NMW compliance. With NMW rates also rising, the risk of non-compliance is increased.

Where employers are found to be underpaying NMW over the previous six years, they must pay the arrears back to the underpaid workers (including ex-workers) and can face penalties of up to 200% of the underpayment. The Department for Business and Trade also publish the names of employers that fail to comply with NMW laws as a deterrent to others.

Employers must therefore ensure they have controls and processes in place to monitor the impact of salary sacrifice on NMW compliance, particularly where they may have more than one salary sacrifice arrangement. Such checks must be able to aggregate all salary sacrifice arrangements and must also be able to capture the impact on pay at the point the employee is being enrolled into the arrangement. In the case of pension salary sacrifice, employers must be able to capture and calculate the impact on NMW from any request to make additional voluntary contributions to the pension scheme (usually around the end of the year or when bonuses are paid) before it is accepted.

Where it looks like a breach of NMW may occur, the employer may choose to prevent the worker from joining the scheme in the first instance, or else impose a limit on the amount the worker can sacrifice. It may also result in the need to report a benefit in kind for tax purposes differently, depending on what the salary sacrifice was for.

Other national minimum wage risks cannot be ignored

But it’s not just salary sacrifice that presents a risk to NMW compliance. NMW is about a calculation rather than a rate of pay. There are various steps that all employers should take before looking at the impact of salary sacrifice.

The first step employers should take in ensuring NMW compliance is to determine which worker categorisation each worker will fall into for NMW purposes. The types of work are ‘time’, ‘salaried’, ‘piece rate’ and ‘unmeasured’ and each requires certain conditions in the employment contract to be satisfied.

If a worker is incorrectly categorised, they may not receive the correct NMW rate, hours worked may be incorrectly recorded, payments may not be made in the correct pay reference periods, and/or processes and controls used to track compliance by the employer may be incorrect.

What should employers do?

The increases in NMW rates and NICs will place further budgetary pressures on employers. But it also means they will have less wriggle room for mistakes.

Employers should be reviewing budgets, undertaking modelling, and considering what they can put in place to mitigate the extra costs.

But they should not lose sight of the fact that NMW compliance is also a priority, particularly where they seek to maximise efficiencies from salary sacrifice arrangements. Given the penalties that apply, and the potential reputational damage which can be caused through naming and shaming, employers should regularly review their processes and procedures, making swift changes if any breaches are identified.

For more information, please get in touch with Susan Ball, Charlie Barnes or your usual RSM contact.