Offering pensions through salary sacrifice

Offering pensions through salary sacrifice can result in savings but may not suit all staff, says Jamin Robertson

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Lured by the National Insurance (NI) and tax savings on offer, employers have been drawn in large numbers to set up salary sacrifice arrangements for pension plans. Employee Benefits/Aegon Trustee Solutions pensions research 2006 revealed 30% of employers now offer a pension scheme in this way.

For both employers and staff, this is usually a win-win situation. According to KPMG, a scheme with 5,000 active members each contributing an average of £1,250 per annum can result in total annual savings of over GBP687,000 for employees and £800,000 for employers.

Most of the main types of pensions can be offered through salary sacrifice, including final salary, defined contribution, group personal pensions and stakeholder schemes.

Organisations may choose to enlist outside expertise to implement a salary sacrificed pension arrangement, although it can be done in-house if the requisite employment law and tax expertise is available.

Matt Waller, principal flex consultant at Benefex, explains that good advice is essential to ensure the scheme is rubber-stamped by HM Revenue & Customs (HMRC). "The Revenue will only approve the tax and National Insurance status of a scheme retrospectively. They will pass comment on it once it’s live so that can be quite a risk, potentially, if you’ve had the wrong advice."

The first step towards implementing a scheme is to carry out a feasibility study. This will ascertain whether scheme rules can be amended for salary sacrifice to take place, reveal the likely savings that will be available, review pension trust deeds and employment contracts, and confirm the current pay structure.

The study will also identify if salary sacrifice is unsuitable for the organisation, as in the case where large numbers of staff are paid close to the national minimum wage. Lower-paid employees or those who are eligible for tax credits may be better off remaining outside the scheme.

In addition, members of final salary pension arrangements close to retirement may find that their entitlements are adversely affected, due to the salary reduction. Ian Hopkinson, head of people services for the large corporate sector at KPMG, says: "You need to flush out the people that are definitely going to be worse off, generally exclude them from the arrangement, and communicate to them why they are excluded."

Other areas to consider include employees’ entitlement to pay-related benefits, such as bonuses and overtime rates which may be calculated as a percentage of salary. In most cases, employers typically continue to base these entitlements on pre-sacrificed, or notional pay, to ensure they are not adversely affected by salary sacrificing pension scheme arrangements.

Employers will also need to consider whether administration and software are up to scratch. A period of communication can then be undertaken to educate staff, attract buy in, and drive those NI and tax savings. David Cassidy, chief executive of the financial education provider JP Morgan Invest, says: "People [depending on] bonuses may have only a small window of time to make their decision, so a lead-in period of education on salary sacrifice is essential."

Employment contracts, meanwhile, may need to be altered, heightening the need for thorough communication that should be extended to include trade unions. "If you increase [employer] contributions using some of the savings, that’s very persuasive for the trade unions," says Hopkinson.

If you read nothing else, read this…

  • Moving a pension scheme to a salary sacrifice arrangement may deliver National Insurance (NI) and tax savings but can adversely affect state benefits for staff involved.
  • Employers need to consider whether current pension scheme rules allow for salary sacrifice and if they have the capacity to handle changes to the scheme.
  • Investing employer NI savings back into the pension schemes will help to sell the benefits of salary sacrifice to employees.