Employee Benefits flexible benefits supplement 2006 – Feature: The risks of flex

Flexible benefits schemes carry with them a number of risks which employers are advised to avoid, such as the potential for increased liability if employees perceive that they are losing out due to poor communication, explains Nick Golding

Case study: Mitsubishi UFJ Securities

To get anywhere in life it is generally necessary to take a few risks. However, employers running a flexible benefits scheme would be well advised to make themselves aware of potential risks and legal issues and to avoid them at all costs. Many employers believe that offering an interesting flex package will help to motivate and retain staff. And as a contented workforce generally helps boost productivity, for most employers flex is deemed worthwhile. But one area in relation to flex that can be fraught with risk is the operation of salary sacrifice arrangements. These tend to be potential banana skins, because despite the tax advantages for both employers and employees, organisations which shy away from effectively communicating the implications of such a scheme could find themselves in hot water.

Legally, employers need to firstly determine which of their employees can and cannot take part in such a scheme. Martyn Phillips, director of employee benefits at Prudential, explains: "You cannot pay an employee below the national minimum wage, so employers should have a mechanism in place to identify those employees who cannot use salary sacrifice benefits." Employees’ entitlement to state benefits may also be affected. Those who take part in salary sacrifice schemes to obtain perks such as bikes for work or childcare vouchers will see a reduction in the amount of National Insurance (NI) they pay. This may subsequently impact on the amount available to them through state benefits, such as maternity pay and a state pension. If this risk is not communicated then it could result in a backlash against employers. "Eligibility for a second state pension is calculated by NI contributions and by not explaining this impact to staff, employers run the risk of employees coming back and saying, ‘hold on, no-one told me that would happen’," explains Phillips. Another, albeit less common, risk around salary sacrifice benefits concerns how a scheme is set up.

Salary sacrifice arrangements do not need to be approved by HM Revenue and Customs (HMRC), but must be set out in agreements between an employer and its staff. HMRC does, however, set out guidelines on how schemes should be set up, so employers which do not follow these instructions may end up being liable for hefty tax costs when a tax inspector visits. "The main risk here is that if a flex scheme were implemented and, at some point in the future, HMRC audited the company and discovered that the salary sacrifice arrangements did not constitute a valid salary sacrifice, then there could be back National Insurance (NI) for the employer to pay," says Phillips. As a result, forward-thinking employers are ensuring their salary sacrifice arrangements are checked over by tax experts before an audit. "Engaging with your tax inspector prior to the launch of the scheme and providing them with a range of materials which you will be using, will allow them to pass judgment on the scheme," adds Phillips. When employees finally begin making repayments through a salary sacrifice arrangement, issues can arise if they decide to leave their employer mid-way through a scheme.

Paul Farrell, head of flexible benefits at Aon Consulting, explains: "If an employee leaves mid-way through a scheme then obviously it is the recovering of the full payment [amount] which can be a problem." One solution is to take pre-emptive measures such as writing up a policy on repayments, stating that those employees wishing to leave the company before payments are complete must repay the full amount due on the date that they leave. Victoria Goode, partner at law firm Lewis Silkin, explains: "Documentation should make it clear before employees begin sacrificing their salary that if an employee leaves part way through a scheme, that employee is liable to pay an early termination penalty to cover the cost of the benefit." More prudent organisations may not want to run the risk of employees running off without paying the bill in full, and may decide to plan for this possibility by weighting early monthly repayments more heavily.

Paul Bartlett, head of product development at Grass Roots, says: "One solution is to create a kind of ‘slush fund’ whereby employers overcharge staff for a benefit and cover the risk this way." Employers are also advised to ensure staff are aware that they will lose the right to any tax breaks offered through tax-efficient benefits schemes should they leave part way through paying for them. "The terms of salary sacrifice need to be made clear, in particular, the fact that the tax breaks are lost should an employee leave the organisation and [they must] pay the outstanding amount on the benefit," explains Bartlett. One factor that employers can do little about is a government decision to remove tax breaks around a benefit, as was the case with the home computing initiative (HCI) earlier this year. In such cases, employers face being left with the headache of realigning payroll systems and a demotivated workforce.

Jane Richards, reward manager at accountancy firm BDO Stoy Hayward, explains: "The risk here is that you put so much time and effort into communicating a new benefit to staff when setting it up and at any moment it can be taken away. When a reward is taken away from employees. it can feel like a punishment." One way for employers to mitigate the risk is by ensuring they offer a comprehensive programme for staff to choose from. This way, there will not be as much pressure placed on one benefit in terms of popularity, so if it is removed, employees will have other options to soften the blow. Another, often more pressing, concern for employers is data security, although providers do not believe this is as much of a risk at it may seem. While employers will use providers to administer and offer guidance on a flex scheme, most sensitive information will remain with the employer. "More often than not, the data passed to the provider is not highly sensitive information. The provider doesn’t need this and it is kept by the employer," says Bartlett.

More legal issues lie ahead with age discrimination laws due to come into effect in October. Employers will need to ensure that their flex schemes comply with the new legislation, in particular where healthcare benefits are provided as part of the package. Inez Anderson, tax partner at Smith & Williamson, explains: "Older employees may want to take advantage of additional healthcare cover because they want to benefit from the corporate discounts whereas younger employees may not be so concerned. "The provider then puts the price up as it realises that it is dealing with high-risk employees." This leaves employers with the risk of being seen as discriminatory as it is offering the same benefit but at different prices dependent on employees’ age. One way to side step this problem is for employers to level out the cost of the benefit among all employees, offering it at a similar price regardless of age. "If all younger employees are not interested, the employer may have to make some sort of subsidy to make the benefit more attractive," explains Anderson.

The risks around flexible benefits

Salary sacrifice Employers should ensure they effectively communicate salary sacrifice scheme rules to employees to avoid a backlash from staff. Salary sacrifice may affect an employee’s right to state benefits, such as a state pension.

Age discrimination Employers need to ensure that the manner in which benefits are offered is not discriminatory against staff on the basis of age. Benefits which potentially fall into this category include health insurance because the price typically tends to be higher for older employees than for younger workers.

Employees leaving mid-way through a scheme Employers need to make it clear that if an employee takes part in a salary sacrifice arrangement and decides to leave the company before making a full payment for the benefit, the individual is liable for the outstanding cost in a lump sum, with no tax breaks.

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Collapse of a scheme As happened with the home computing initiative earlier this year, employers should be aware that some benefits have a shorter life span than others. If tax breaks around a benefit are removed, the organisation faces a demotivated workforce and a payroll administration task.

Case study: Mitsubishi UFJ Securities Mitsubishi UFJ Securities International launched a flexible benefits scheme at the beginning of the year. With a large proportion of its perks being offered through salary sacrifice, it directed employees to an online terms and conditions form outlining the rules. This forced staff to read about the implications of salary sacrifice arrangements and tick a box to say they agreed to the terms and conditions of their involvement. Glenn Coleman, head of compensation and benefits, explains: "Nearly everything we have done on benefits requires salary sacrifice so we put together a couple of paragraphs so that if employees wanted to get involved, they actually agreed to the terms." Although the financial services company is concerned about the risks surrounding salary sacrifice, it is less concerned about the risk of tax breaks being removed from further benefits as happened with HCI. "We’re not worried about other benefits being taken. [HCI] was an obvious one that stood out a mile, it was almost too good to be true, so it won’t happen again," he adds.