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Salary sacrifice pensions have a range of tax benefits for both employers and employees. They can also help businesses to attract the best candidates during the recruitment process.
Read on to find out how salary sacrifice pensions work, the tax benefits, and some of the best-known schemes.
A salary sacrifice scheme is when an employee gives up some of their wage for a benefit such as a cycle to work scheme or childcare vouchers.
One of the most popular salary sacrifices is for an employee to exchange a portion of their salary for higher pension contributions from their employer.
For many employees who take a salary sacrifice pension, their take home pay remains the same but their monthly pension contributions are much higher.
This is because by reducing their gross salary, their income tax and Class 1 National Insurance contribution (NIC) payments are lower.
The employer also makes a saving on their tax contributions, which they can choose to keep or add as a further contribution to the employee’s pension pot.
A salary sacrifice pension is something that has to be offered by an employer and agreed to by the employee.
When an employee agrees to take a salary sacrifice to put towards their pension, you’ll need to agree a new contractual salary with them.
This means their contract will need updating. Generally this is done by adding a clause to the contract that explains the details of the salary sacrifice.
It’s worth getting legal advice before changing employee contracts, as well as reading government guidelines on salary sacrifice pensions.
The employee will need to decide how much of their salary they want to sacrifice. Most people give up between five and 15 per cent, but it’s important to remember that:
Since 2012, it ’s been a legal requirement for employers to add their employees to a workplace pension if they’re aged 22 or above and earn more than £10,000.
Employees must make a monthly contribution of eight per cent of their salary to their pension, made up by a minimum contribution of three per cent from the employer and five per cent from the employee.
When an employee opts in for a salary sacrifice pension, their existing contributions (usually five per cent) will stay the same. The existing contribution from the employer (three per cent minimum) will still be paid but they’ll also contribute the employee’s sacrificed salary (e.g. £1,000) to their pension pot.
So even though the employee is contributing more to their pension from their salary, it’s counted as an extra employer contribution.
Paying into a salary sacrifice pension gives people extra pension tax relief. This is because you don't pay income tax or National Insurance on the portion of your salary going straight into your pension pot.
All the tax savings made by employees and employers are instant – there’s no need to claim them back later.
If one of your employees earns £30,000 a year and opts in to sacrifice £1,500 of their salary to save for their pension, here’s how it would work:
You can use Legal & General’s salary sacrifice pension calculator to get an idea of the savings you and your employees could make. You can also get more information on NICs by using HMRC’s payroll checker calculator.
There’s a range of pension providers offering salary sacrifice options. If you’re thinking about offering salary sacrifice, it’s worth speaking to your existing auto enrolment provider to see if it’s available.
Here are four well-known providers of salary sacrifice pensions:
Salary sacrifice pensions help people to save more money for later life without significantly affecting their take home pay.
They offer a legal way for employers and employees to reduce their National Insurance payments, and employers can then choose to keep the savings or contribute them to the employees’ pensions.
Employers who offer salary sacrifice pensions and pass the tax savings on to employees can benefit from a happy workforce. On top of this, it also puts them in a strong position when recruiting for new staff as prospective employees will be looking for differentiators like benefits in kind.
In most cases salary sacrifice pensions are win-win for employers and employees, but there are a few potential downsides to consider.
The main thing for employers to consider is the extra admin involved with offering a salary sacrifice pension scheme.
You’ll need to make sure that:
That being said, since the introduction of auto enrolment, most businesses are likely to already have the systems in place to manage pensions effectively.
As we already mentioned, employees who opt in for a salary sacrifice pension can save more for their retirement while often taking home the same (or more) monthly pay.
The main thing to remember is that by taking a salary sacrifice your gross annual salary is lowered. This could cause problems if:
Do you have any unanswered questions about salary sacrifice pensions? Let us know in the comments below.
Conor Shilling is a Copywriter at Simply Business with over two years’ experience in the insurance industry. A trained journalist, Conor has worked as a professional writer for 10 years. His previous experience includes writing for several leading online property trade publications. Conor specialises in the buy-to-let market, landlords, and small business finance.
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