Imagine a financial strategy that allows your employees to save more for their retirement, while your business simultaneously benefits from lower costs. That's the reality of a salary sacrifice pension scheme - it’s a clever, tax-efficient way to invest in your team's future and your company's bottom line. In this guide, we'll outline everything you need to know and talk you through how to introduce this valuable benefit to your team.
What is salary sacrifice?
At its core, salary sacrifice is a straightforward but innovative arrangement. It's an agreement between an employer and employee where the employee voluntarily agrees to receive a lower cash salary. In return, they get non-cash benefits such as child care vouchers, a company car, or additional employer pension contributions.
Over the years, this strategy has grown in popularity due to its mutually beneficial nature. While the employee enjoys the advantage of non-cash perks, the employer also benefits through lower employer National Insurance contributions due to the reduced cash pay.
What are salary sacrifice pension schemes?
Salary sacrifice pension schemes are a specific application of the salary sacrifice concept, primarily focused on pensions. The portion of the salary that the employee gives up, often referred to as the 'sacrifice', is redirected straight into their pension fund.
This method of contributing to a pension has become increasingly common in the UK, especially with changes in pension legislation over the years that encourage more proactive retirement planning. In essence, the sacrificed portion of the salary lowers the employee's taxable income, thereby reducing the amount of tax paid and effectively providing immediate tax relief.
How do salary sacrifice pensions work?
Think of it as a simple swap: an employee agrees to take a lower salary and, in return, the employer puts that exact amount directly into the employee's pension pot.
For example, let's say an employee earns £35,000 a year. They decide to "sacrifice" or give up £2,000 of their salary for their pension. Their official new salary becomes £33,000. Their employer then puts that £2,000 straight into their pension fund.
This simple change has some big benefits.
For the employee: Because their official salary is lower, they pay less in income tax and National Insurance. They get to keep more of their money, which goes directly into their retirement savings. For someone on a standard tax rate, this can add up to a significant saving on the money they put into their pension.
For the employer: With a smaller total salary bill, you also pay less in National Insurance contributions. It's a great deal for everyone. Your employee's pension pot grows faster, and you both save money on taxes.
This is why salary sacrifice pensions are a popular and smart choice for businesses in the UK. They are a perfectly legal and financially smart way to help your team save for the future.
Setting up your salary sacrifice pension scheme
Step 1: Confirm that your pension scheme supports salary sacrifice arrangements
Here are some popular pension schemes that do support salary sacrifice arrangements:
NEST
Smart Pension
Penfold
Now: Pensions
Aviva (they often call it “salary exchange”)
The People’s Pension
Tide Payroll has a built-in integration with NEST. This means that calculations are automated, as well as pension scheme updates. So that you don’t have to log in to your pension platform every month.
Step 2: Get agreement from your employees
Make the team aware of what salary sacrifice pensions means for them, and let them know that you need their agreement for a contract update.
Note: To offer a salary sacrifice pension scheme (or any kind) to an employee, it cannot take them under the National Minimum Wage (The National Minimum Wage applies to those aged between 16 and 20 and varies based on the employee’s age - see rates on HMRC’s website)
Step 3: Update wording of employee contracts, and ask employees to re-sign
Here’s a handy snippet you can adapt for your contracts (this is not legal advice, and it is your responsibility to adapt it as you see fit):
The government requires employers to enrol their employees who are eligible for auto-enrolment into a workplace pension scheme.
We have selected [Pension Scheme Name] as our pension provider.
If you meet the auto-enrolment criteria, you will be eligible for the Company's Salary Sacrifice Pension Scheme, whereby you agree that a specified portion of your gross salary, in line with auto-enrolment rules, is directly contributed by the Company to your pension fund through [Pension Scheme Name].
However, if participating in the Salary Sacrifice Scheme results in your earnings falling below the National Living Wage, you will remain within the standard Defined Contribution Scheme with [Pension Scheme Name].
You will automatically be enrolled into the appropriate pension scheme upon commencement with the company.
Once enrolled, [Pension Scheme Name] will provide you with further information and log in details, including details on how to opt out if desired.
Step 4: Update your pension scheme to be salary sacrifice
Some pension schemes (eg NEST) will have a portal where you can update your scheme to be salary sacrifice. NEST has created a guide to setting up salary sacrifice through their platform.
For most other providers, you’ll need to message their customer support. In our experience, most schemes can enable salary sacrifice for you in a day or two.
Step 5: Update payroll software to calculate pensions based on salary sacrifice
If someone else does your payroll, you’ll need to ask them to update the software they’re using to factor in salary sacrifice calculations.
We’ve seen some accountants be reluctant to do this and take a while to process updates.
If you use a modern payroll software like Tide Payroll, updating your pensions to be salary sacrifice can be done in 2 clicks.
Is a salary sacrifice pension right for your business?
Before implementing a salary sacrifice pension scheme, employers must undertake a thorough evaluation of the scheme's potential impacts. This includes its alignment with the overall compensation strategy, the ability to absorb administrative costs, and the scheme's attractiveness to current and prospective employees.
The benefits of salary sacrifice pensions
Employer benefits and savings
Employers can make significant savings with salary sacrifice pension schemes. For example, if an employee sacrifices £1,000 of their salary, the employer could save up to £138 on their National Insurance Contributions due to a lower overall salary bill.
Employee benefits and savings
The savings for employees are also notable. An employee in the 20% tax bracket, sacrificing £1,000, can save £200 on tax and an additional £120 on National Insurance contributions. Therefore, the cost to the employee for a £1,000 pension contribution would be only £680.
Things to consider before implementing a salary sacrifice pension scheme
Take-home pay: For employees, a lower cash salary means less immediate income, which could affect their short-term financial planning.
Ability to borrow: Lower take-home pay could impact an employees' ability to borrow, as lenders often consider current income when determining borrowing capacity.
Contribution-based benefits: Reduced cash salary might affect contribution-based benefits such as Statutory Maternity Pay and Jobseeker's Allowance, as these are based on earnings.
Pension contributions: Lower earnings could affect the amount of pension an employee or employer can contribute, potentially impacting the employee's retirement income.
Administrative load: For employers, the process of setting up and maintaining the scheme can add to the administrative load and potentially increase costs.
A thorough understanding of these factors can help businesses and employees make informed decisions about salary sacrifice pension schemes.
Wrapping up
Salary sacrifice pensions offer unique advantages for both employees and employers. However, they require careful consideration and proper implementation. Understanding the what, why, and how of salary sacrifice pensions can enable businesses and employees to make informed financial decisions.
FAQs on salary sacrifice pensions
Can I use salary sacrifice if I earn a low salary?
Yes, but the reduced salary must remain above the National Minimum Wage.
How much salary should I sacrifice for my pension?
This depends on personal circumstances, such as current income needs and future retirement plans.
Is there a limit to a salary sacrifice pension?
There's no set limit, but earnings after the sacrifice must stay above the National Minimum Wage.
What’s the difference between auto-enrolment and a salary sacrifice pension?
Auto-enrolment is a statutory requirement for employers, whereas salary sacrifice is an optional arrangement offering more tax efficiency.
Does salary sacrifice affect state pension?
Potentially, yes. If your salary after sacrifice falls below the Lower Earnings Limit, it could affect your State Pension.
Can I have a salary sacrifice pension if I’m self-employed?
Salary sacrifice schemes are typically for employees. However, self-employed individuals can still make pre-tax contributions to their pensions, yielding similar benefits.
Image from Unsplash, published by mtimber71
