Pensions Salary Sacrifice

Learn to make Sacrifices (and reduce your tax costs)

It’s easy in 2022 to mistake newspaper headlines for debits on a bank balance.  Rises in fuel costs, heating and electricity bills and the spectre of hyper-inflation are all significantly impacting the cost of living. For many, the squeeze on living costs is about to be exacerbated further by a rise to National Insurance rates. From 6 April until 5 April 2023, National Insurance contributions will increase by 1.25%, with this increase being specifically ring fenced to fund the NHS and other health and social care provision in the UK. In practical terms, this will translate into an immediate reduction to take home pay for many – for example, an employee who earns £50,000 per annum will pay an additional £625 a year in NICs from next month. However, one potential way for employers to help mitigate the rise in NICs is to set up a salary sacrifice scheme as a method of funding pension contributions.  

How does salary sacrifice work?

In very basic terms, a salary sacrifice arrangement is an agreement between an employee and their employer, under which the employee agrees to give up (“sacrifice”) part of their salary in exchange for an equivalent benefit which is funded by their employer. HMRC allows salary sacrifice schemes to be used to fund a range of benefits, including childcare vouchers and cycle to work schemes, but a popular use of salary sacrifice is to pay contributions to a company pension scheme. Under pensions salary sacrifice, the employee agrees to amend their terms and conditions to agree a reduction in their pay which is equivalent to the rate of the pension contributions paid by them to the scheme.   

Salary sacrifice example

Going back to the example of an employee who earns £50,000 a year, if the employee pays contributions of 5% of pay and their employer also pays 5%, under salary sacrifice the employee agrees to a 5% pay reduction of £2500 per annum and agrees that their own pension contributions will be reduced to nil.  In exchange, the employer agrees to make a total pension contribution of 10% of the “pre-sacrifice” salary.  There is no change to the value of pension contributions paid – it is still 10% in total.  However, by contractually reducing the individual’s salary to £47,500, this means that the employee will pay reduced rates of income tax and NICs on this revised, lower figure, and the business will also pay reduced employer NICs on the lower salary.  As well as this, some companies choose to pass on all or part of their own NIC savings to the employees, by way of  either additional pension contributions or to fund some other employee benefit.  

What do employers need to think about?

In theory, salary sacrifice is a neat and fairly straightforward route to achieving reciprocal cost savings between the business and its staff, and also shows that a company is behaving responsibly towards its own staff. However, before implementing salary sacrifice, there are a number of important steps which will need to be taken, including:

• Communicating the arrangement to staff, so that they clearly understand the benefits of salary sacrifice and are happy to sign up to the changes
• Documenting salary sacrifice, and putting in place the necessary contractual agreement with your workforce to vary their terms and conditions and
• Ensuring that the changes take effect smoothly, both as regards processing the changes via your payroll and also implementing the scheme for new joiners in the future

If you are interested in knowing more about salary sacrifice, and whether this type of arrangement would be a good fit for your business, then please contact Andrew Campbell, Head of Pensions, in the first instance.