Pension salary sacrifice – how to make friends (and keep the bosses happy)!

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Whether you’re an agent or working in-house processing pension payments are or will be part of your payroll duties. But are you doing all you can to make those pension payments as efficient to your employer as they can be?

I am still surprised when I come across a workplace pension which isn’t set up under salary sacrifice (sometimes called salary exchange).

When I ask why employees are still paying contributions out of income on which tax and NI have been paid, I’m often told that they know about the idea but are scared of using it. If you are reading this, run payroll and don’t operate salary sacrifice, then don’t let the excuse be that “payroll isn’t up to it”.

Salary sacrifice offers a way to set up pension payments that can allow both employers and their employees to make a saving. If you want to know how it works and what the savings are likely to be there are many good explanations on the web. The best I’ve come across is Aviva’s http://www.aviva.co.uk/adviser/product-literature/view-document.cgi?f=sp57180c.pdf .

So why does salary sacrifice have a reputation for being scary and how can you – payroll – become the safe pair of hands to make it happen? In my experience it’s because employers know there are risks, but don’t know how to mitigate them.

By being aware of and implementing the following safeguards, you can future-proof your employer and win yourself friends throughout your organization.

Safeguards You need to take careful account of all pay-related benefits to make sure they are not reduced by the salary sacrifice e.g. items like overtime, shift etc. may be calculated by reference to the basic rate.

The best way of dealing with these is for it to be established that they will continue to be calculated, both immediately and in the future, by reference to what salary would have been had the salary sacrifice not taken place.  In practice this is often done by using a notional ‘reference salary’ for calculating the benefits. Where members are in defined benefit pension schemes, where the amount of pension is defined by reference to final salary, then a similar safeguard needs to be introduced. Otherwise there could be a big impact both on the value of past and future service pension entitlements.

Future pay rises should always be determined by reference to the pre-sacrifice salary level. What about state benefits? The major potential effect here is on members entitlements to State Second Pension (S2P). The effect of salary sacrifice depends on whether the employee is contracted-in to S2P or whether they are contracted-out, with a bigger impact where people are contracted-in. If you are contracted-in then for the majority of employees’ S2P benefits are directly reduced by salary sacrifice. The complexity of S2P means this is not a straightforward picture but people whose gross earnings are in the range of £14000-£40000 will lose out by amounts which increase the older that they are.

From April 2016 there will be no more contracting in or out, but between now and then, losing S2P benefit could take away a significant part of the gain of salary sacrifice Where salary sacrifice is proposed in a contracted-in situation, payroll can quantify and advise staff on the impact on S2P. Where employees are contracted-out the losses are much less because to a large extent their scheme benefits replace S2P. But lower earners do still get a significant top-up S2P payment which will be directly reduced as their gross salary is reduced.  In most circumstances salary sacrifice will still deliver a substantial net benefit to members, but S2P losses mean that employees will gain a lot less than employers. Employees on very low pay should be excluded from salary sacrifice for two reasons.

Basic State Pension would be affected if the salary reduction dropped a members earnings below the N I threshold (or LEL), which is currently £5824pa

In a similar vein a salary sacrifice would not be allowed if it took members pay below the National Minimum Wage.  Salary sacrifice needs to be properly communicated if it is to gain employee support. (thanks to Kate Upcraft for this important point).

It can be introduced either by members being invited to opt-in or by employees being included but advised of an option to opt-out. While the latter strategy may be pressed to overcome member inertia and suspicion it should not excuse the employer from properly communicating the scheme

Where any proposal is introduced it would expected that it would be accompanied by clear information as to who might stand to lose as well as who might stand to gain. While the gain from NI savings may be similar for employees and the employer, employees may lose out significantly from reduced S2P benefits. This should support suggestions that part of the employers’ savings should be channeled back in some sort of benefit for employees e.g. to offset a part of a contribution increase in a defined benefit scheme or to provide a supplement to the employer contribution in a defined contribution scheme.

Normally an employee using salary sacrifice would be expected to use the arrangement for a year for it to be considered valid.

Where salary sacrifice is being used in conjunction with auto-enrolment you need to take care that each eligible jobholder has the right to opt-out of salary sacrifice independently of the pension opt-out. Fortunately, a decision to opt-out of an auto-enrolment arrangement within a year of joining it, does not invalidate the salary sacrifice arrangement.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to Pension salary sacrifice – how to make friends (and keep the bosses happy)!

  1. The Heaton v Belle principle of a salary sacrifice being in place for minimum 1 year does not apply to salary sacrifice for pensions, child care or workplace car parking. However, the principle does apply to other elements of employer provided benefits.

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