- What is a salary sacrifice pension?
- Who can join a salary sacrifice pension scheme?
- How does a salary sacrifice pension work?
- What are the tax implications of making salary sacrifice pension contributions?
- What are the pros and cons of a salary sacrifice pension?
- Does a salary sacrifice pension affect the State Pension?
If you’re a business owner, pension rules and pension funds can be a source of confusion for both you and your employees. Here, we look at operating a salary sacrifice scheme for your workplace pension, including how the scheme works and which of your employees might be eligible. We also explore the pros and cons so that you can help keep staff members informed about whether it might be right for them.
Salary sacrifice schemes operate in the same way as other workplace pensions whereby both you and your employee contribute to their pension fund. The main difference with salary sacrifice, compared to other workplace pensions, is that the contributions are deducted from the employee’s gross pay, rather than their net pay. All of their pension contributions will be made by you and classed as ‘employer contributions’.
Salary sacrifice is also sometimes known as ‘salary exchange’.
Other workplace pension schemes are usually set up on a ‘relief at source’ basis, where the employee’s contributions are made from their net pay and attract tax relief. With salary sacrifice schemes, in addition to the tax savings, employees pay reduced National Insurance (NI) contributions too.
Not all members of staff will be eligible to join a salary sacrifice scheme and you may have to operate another form of workplace pension for non-eligible employees. To be eligible, deductions cannot lower your employee’s salary to below the minimum wage.
Employers may choose to operate a salary sacrifice pension scheme and a relief at source pension scheme in tandem. If you have employees who aren’t salaried or work varied hours each month, it can be difficult, and require extra resource, to calculate their salary sacrifice each month. Therefore, employers may want to consider putting these employees on a relief at source scheme instead.
Salary sacrifice can also affect employees’ entitlement to working tax credit and child tax credit, therefore they may choose to be enrolled on a relief at source scheme or opt out altogether.
As an employer you are legally obligated to provide a workplace pension scheme and auto-enrol eligible staff. However, the type of pension scheme you operate is up to you and what is best for your employees. You may choose to operate salary sacrifice, relief at source, or both.
If you enrol your employees on a salary sacrifice scheme, you’ll need to make sure this is formally recorded in their contract. Any changes that are made (for instance, if your employee chooses to opt out at a later date) must also be officially noted.
As an employer, the minimum you can contribute is 3% of your employee’s salary, while employees typically contribute 5%.
Full guidance can be found at GOV.UK.
Salary sacrifice will lower the amount of income tax and National Insurance (NI) your employee will pay. It can also lower your employer NI contributions as it will be based on a lower salary.
As an employer, you can choose to pass on those NI savings to your employee, but that’s entirely at your discretion.
For an employer the benefit is reduced NI payments if you choose not to pass these on to your employees. For employees there are multiple benefits, but salary exchange can have disadvantages for some.
Salary sacrifice pro (for employees):
- Lower income tax;
- Lower NI contributions;
- Increased contributions to pension fund and/or increased net pay.
Salary sacrifice con (for employees):
- Can impact other salary-based benefits including life insurance, maternity pay and tax credits.
In most cases, contributing to any workplace pension will not affect your employee’s State Pension. However, it could affect it, if the amount of salary they sacrifice takes them below the threshold for NI contributions which is currently £184 per week. If you have employees that would fall into this category, then you can put them into a relief at source scheme instead.
Pensions advice and guidance
Ensuring your employees feel valued is a crucial part of any business but navigating pensions and knowing you’ve got the best arrangements for your employees can be tricky.
Levels and bases of taxation and tax reliefs are subject to change and their value depends on individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.