Pension Salary Sacrifice: How to Balance Employer Costs & Employee Benefits

Managing costs is a challenge every business faces, and employee benefits are often a target for potential savings. Director, Ashleigh Wood explores how salary sacrifice for pension contributions can help you improve your bottom line without compromising on what's important to your team.

Workplace pensions are a cornerstone of employee benefits in the UK, it's an investment in your employees' futures, and a key factor in their overall compensation package. It's also a significant financial commitment for business owners. But here's something a lot of employers don't know: offering a pension salary sacrifice scheme can actually save you money on your business outgoings.

While salary sacrifice has gained popularity in recent years, research from Workplace Pensions Direct and YouGov reveals a surprising statistic: only around 50% of employers currently offer it for pension contributions. What's holding everyone back? Pension salary sacrifice can be an effective way to reduce employer National Insurance costs while also helping employees build their retirement pot.

• What is Pension Salary Sacrifice?

• How Pension Salary Sacrifice Works

• Understanding the Benefits of Pension Salary Sacrifice

• The Annual Allowance: What Does It Mean for Employees?

• Implementing Pension Salary Sacrifice: Key Considerations for Employers

What is Pension Salary Sacrifice?

Pension salary sacrifice allows employees to give up a portion of their salary in exchange for the employer paying that amount directly into their pension pot. This reduces the employee's taxable income and National Insurance contributions, while also providing savings for the employer.

How Pension Salary Sacrifice Works

The process is relatively straightforward:

1. Agreement: The employer and employee agree on the amount of salary to be sacrificed. This is typically a fixed amount or a percentage of the employee's salary.
2. Deduction: The employer deducts the agreed-upon amount from the employee's gross pay. This deduction is before tax and National Insurance are calculated.
3. Contribution: The employer then pays this sacrificed amount directly into the employee's designated pension plan. This is an exempt benefit and therefore the employee will not suffer income tax or National Insurance on this contribution. The employer will also not be liable to National Insurance on this benefit.
4. Tax and NICs: Because the employee's gross pay is now lower, both income tax and National Insurance contributions are calculated on this reduced amount. The employee pays less income tax and National Insurance, and the employer's National Insurance liability is reduced.

Understanding the Benefits of Pension Salary Sacrifice

For Employers

• Reduced National Insurance Contributions (NICs): Employers are obligated to pay NICs on employee earnings above a specific threshold. Salary sacrifice reduces the employee's taxable income, thereby lowering the amount on which NICs are calculated. This directly translates to lower NICs payments for the employer.
• Reinvesting Savings: The NICs savings can be reinvested back into the business to fuel growth and improve operations. These funds can be strategically allocated to various initiatives, such as funding new projects, enhancing employee benefits to attract and retain talent, or upgrading equipment and infrastructure.
• Significant Savings Potential: The NICs savings are particularly impactful for companies with larger workforces and higher-earning employees. Increased employee participation in the scheme leads to greater overall NICs reduction, while higher earners generate larger savings per employee due to their higher National Insurance liability.

For Employees

• Increased Pension Contributions: The sacrificed salary amount is paid directly into the employee's pension pot by the employer. Employees who opt for salary sacrifice also benefit from a reduced income tax liability.
• Reduced NICs and Income Tax: While the primary National Insurance contributions benefit goes to the employer, employees also experience a slight reduction in their own NICs payments due to their lower taxable income.
• Tax Relief on Pension Contributions: For high earners, pension salary sacrifice simplifies the process of contributing to their pension without the need for separate tax relief claims.

The Annual Allowance: What Does It Mean for Employees?

The annual pension allowance is the maximum amount an individual can save into their pension pots each tax year (April 6th to April 5th) without paying extra tax. This also includes any increase in a defined benefit scheme in a tax year.

For the current tax year (2024/2025), this limit is £60,000. A tax charge will only be incurred if total pension savings exceed this amount.

What Counts Towards the Annual Allowance Limit?

The annual pension allowance applies to all private pensions held by an individual. This means if someone has multiple pensions, the allowance covers the total amount contributed across all of them. This includes:

• Defined Contribution Pension Schemes: This includes all payments made into these types of pensions. Whether it's money you've personally contributed, contributions from your employer, or even payments made by a third party.
• Defined Benefit Pension Schemes: In addition to contributions, the allowance also accounts for any increase in the value of your accrued benefits within these schemes during the tax year. This means any growth in your future pension payout, based on your salary and service, is factored into your allowance usage.

Tapered Annual Allowance for High Earners

Individuals with "threshold income" exceeding £200,000 and "adjusted income" exceeding £260,000 in the current tax year may be subject to a reduced, or "tapered," annual pension allowance. These income thresholds and the resulting tapered allowance amounts can change from year to year.

Implementing Pension Salary Sacrifice: Key Considerations for Employers

Before implementing a pension salary sacrifice scheme, employers should consider the following:

• National Minimum Wage Compliance: Employers must ensure that salary sacrifice does not reduce an employee's take-home pay below the National Minimum Wage. Robust systems must be in place to monitor this.
• Impact on Gross Pay and Related Benefits: While beneficial, salary sacrifice reduces gross pay, which can impact an employee's eligibility for certain benefits, such as maternity/paternity pay, often calculated based on gross salary.
• Maintaining Compliance: Salary sacrifice is subject to regulations, including those concerning wages and auto-enrolment. Professional advice is essential to ensure ongoing compliance, and clear written agreements should be established with each participating employee.
• Payroll Integration: Salary sacrifice deductions must be accurately processed through the payroll system. Employers should have an early consultation with their payroll provider for a smooth implementation.
• Employee Communication: Open and transparent communication is paramount. Employees must fully understand the scheme's intricacies, including the benefits, potential implications, and operational details.

A Balanced Approach to Salary Sacrifice

By carefully considering the advantages and potential trade-offs, both employers and employees can use salary sacrifice to build a more secure financial future. A balanced approach, incorporating open communication, thorough planning, and professional guidance, is key for maximising these benefits.