Salary sacrifice works by employee’s exchanging some of their salary in return for an extra benefit from their employer. It is often used in return for additional employer pension contributions as, in doing so, it can be a helpful tool for both employers and employees to reduce their National Insurance contributions.
With the cost of living increasing at nearly its fastest rate in 40 years, including the cost of a tank of petrol reaching record highs and the average annual home energy bills set to hit £2,500 a year, businesses know that every penny counts for their employees.
Even though business leaders will be sympathetic to the pressures that their staff’s personal finances are under, their own corporate challenges might prevent them from increasing salaries to support staff in meeting rising costs. This is where salary sacrifice – also known as salary exchange – can be an extremely compelling strategy to help employees make their money go further.
Salary sacrifice works by employee’s exchanging some of their salary in return for an extra benefit from their employer. It is often used in return for additional employer pension contributions as, in doing so, it can be a helpful tool for both employers and employees to reduce their National Insurance contributions.
Often, the money that is saved by an employer every year through implementing pension salary sacrifice, not only covers the cost of putting it in place, but can also be redirected towards benefits that can help employees during this financially challenging time.
It’s difficult to know exactly how many firms take advantage of salary sacrifice, with the latest data from CIPD Reward Management Survey April 2022 showing that just 29% of employees from SMEs have such an arrangement with their employer.
Salary sacrifice is often used in return for additional employer pension contributions. For instance, if someone who paid £100 a month into their pension as an employee contribution instead exchanged this amount of salary in return for an additional employer pension contribution of £100 a month they, and their employer, could save National Insurance contributions on the amount.
While many might view pension salary sacrifice as positive, it is vital that it is set up in the correct way and any potential impacts communicated clearly to employees as it is not suitable for everyone. Just as employees now expect a better work/life balance, many may expect an improved pay/benefits balance as well.
Pension salary sacrifice can be a compelling tool, but employers must remember that it is a formal arrangement that requires certain rules to be followed.
As an example, the employment contract of every employee that opts into or out of a salary exchange scheme must be altered to reflect their inclusion or exclusion and the impact on their gross pay.
There are other stipulations that employers must be mindful of, notably that a salary exchange arrangement must not reduce an employee’s earnings below the National Living/Minimum Wage.
Furthermore, consideration needs to be given to salary based benefits such as pay increases and bonuses, life assurance and sick pay, and whether they are based on the ‘notional’ or ‘reference salary’ – the employee’s salary before the sacrifice is applied – or on the reduced, post-salary sacrifice pay. Either way, this must be made clear to all employees.
Pension salary sacrifice can also affect State benefits such as the new State Pension, or Statutory Payments such as Statutory Sick Pay and Statutory Maternity Pay. However, as long as employers communicate clearly about all aspects of pension salary sacrifice, they may find that many of their employees can decide if it is suitable for them and will appreciate the benefits given the pressure household finances are under.
By an employee sacrificing part of their salary for an equivalent additional employer pension contribution prior to National Insurance being levied, the amount of take-home pay can rise.
An employee earning £40,000 per annum and paying 5% into their pension could achieve an uplift in their disposable income, as they would receive a pay rise equivalent to approximately 1% of their salary.
Furthermore, based on the new employer National Insurance contribution rate of 13.8% from 6 November 2023 their employer could save £23 per month in reduced National Insurance payments.
Firms could use some of this saving to provide other benefits to help employees during the cost-of-living crisis, or offer to increase the employer contribution to staff pensions. When deciding what benefits to offer though, firms must consider various other factors before implementing a pension salary sacrifice scheme.
One of the first questions that employers need to tackle in terms of implementing a pension salary sacrifice scheme revolves around enrolling staff on to it. Asking staff to opt in, or implementing the scheme firm-wide and asking anyone who wants to opt out to do so, is arguably the first consideration among a host of pension salary sacrifice scheme design considerations.
Furthermore, firms must ensure that they produce quality documentation to clearly communicate to staff all the facets of the pension salary sacrifice scheme, while ensuring that updates are made annually to ensure all paperwork reflects any specific tax changes within a tax year.
Due to the level of preparation required to implement new schemes, or to audit existing ones, it can be sensible for firms to set out a realistic timeline under which their schemes will be launched or refreshed. Taking the time to ensure any pension salary sacrifice scheme truly benefits your employees will be worth it, for them and your firm.
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