Salary sacrifice
Written by Ray Coman
Salary sacrifice is an employment agreement for reduced earnings in place of other benefits. The aim is typically to replace taxable income with non-taxable income.
Most benefits in kind are treated as taxable. Therefore, salary sacrifice schemes are usually only arranged for non-taxable benefits, such as:
- Childcare vouchers;
- Cycle to work arrangements;
- Ultra-Low Emission vehicles; and
- Workplace pension.
From April 2017, any other benefit will be taxed at the higher of the salary foregone and the amount assessed under the benefit in kind rules.
Childcare vouchers are no longer available since October 2018 and have been replaced by a childcare fund. A childcare fund is arranged directly with gov.uk and not via private arrangement with the employer.
Salary sacrifice is only practical where:
- An employee has opted out of auto-enrolment; and/or
- There is no longer a legal requirement to pay a pension because pay exceeds the upper earnings limit for pension.
Consequently, the tax savings of a salary sacrifice are not enjoyed as often as they could be.
Additional voluntary contributions
Net pay arrangement vs relief at source
Director only companies
Auto-enrolment is basically the requirement to pay a pension as a fixed percentage of salary. It is possible to opt out. For a company with no employees and only directors, opting out increases flexibility. Pension payments can be paid at any time and in any amounts. The payments are typically paid as employer contributions to save national insurance. The arrangement is effectively a salary sacrifice, although directors rarely formalise an agreement with themselves to pay any salary. The salary arrangements are also kept flexible.
Autoenrollment
Parties to an employment contract have reason to favour the auto-enrolment scheme over other pension arrangements. The pension is fixed through the UK and enforced by the Pension Regulator. Notwithstanding, a salary sacrifice arrangement can save both employer and employee from national insurance. An employee pension contribution is not deducted from pay subject to national insurance. If restructured as an employer contribution, a saving can be achieved.
Where an employee has auto-enrolled, the regulation imposes upon the employer to pay the minimum fixed percentage of pension by reference to earnings. Reducing earnings would therefore have limited impact on the statutory pension payable.
An employer cannot compel an employee to sacrifice salary; however, an employee can oblige an employer to make pension contributions.
For example
A pension requirement is only applied to income between the lower limit and the upper limit of earnings. For 2019-20, those limits are £6,136 and £50,000. The statutory rates are 5% employee contribution and 3% employer contribution.
If an employee earns between the earnings threshold and upper limit (between about £8,628 and £50,000 for 2019-20) the employee's national insurance saving is 12% and employer’s is 13.8%.
Let us say the employee has a salary of £46,136. Pensionable pay is therefore £40,000. The employee's pension contribution would be 5%, or £2,000. The employee saving is £240 and the employer saving is £276. A combined yearly saving of £476.
Additional voluntary contributions
In 2019-20, the upper earnings limit (for national insurance) is aligned with the upper level of qualifying earnings (for pension.) The upper limit is £50,000.
Once the upper level of qualifying earnings has been exceeded, pension contributions thereafter are made voluntarily by the employee or as under the contract agreement. Therefore, employees with a salary over £50,000 are still only required by the regulation to pay the amount that applies to a £50,000 salary.
Employee contribution rates fall to 2% on earnings above the upper earnings limit, whereas employer contributions are fixed at 13.8%. Once income exceeds £50,000, a lower rate of saving from salary sacrifice would apply. Nevertheless, the saving in nominal terms is higher.
In another example the employee has a salary of £66,136. Pensionable pay is therefore £60,000. Picking an arbitrary amount, the total pension -both fixed percentage and Additional Voluntary Contributions (AVCs) - is £10,000. The employee saving is £200 and the employer saving is £1,380. A combined yearly saving of £1,580. The employee savings is slightly lower than the earlier example.
Employees paid monthly are assessed to national insurance using one twelfth of the annual allowance. An opportunity to save further national insurance could be achieved by sacrificing pay unevenly through the year.
Employment allowance
Employer’s national insurance up to an annual limit is exempt from tax. For 2019-20 this limit is £3,000. The incentive for cumbersome salary sacrifice arrangements is thereby reduced for employers whose national insurance is significantly covered by the exemption.
Practical considerations
A reduced salary would usually require a rewording of employment contracts. A separate salary sacrifice contract is usually drawn on an addendum. Employee contributions are typically deducted from gross pay shown on a payslip. Increased pension contributions agreed via salary sacrifice are usually therefore made solely as employer contribution.
Conclusion
Salary sacrifice tends to be better suited to:
- More senior staff in which the employment relationship depends less on statutory entitlement.
- Higher income staff in which the NI savings in absolute terms are greater.
- Employees closer to retirement who can access the pension pot sooner.
Reducing pay through salary sacrifice could:
- Result in lower statutory maternity pay;
- Breach minimum wage requirements; and
- Lessen income which is assessed for mortgage purposes.
It is possible to have two employment pension plans. The one a workplace pension that fits the auto-enrolment regulation and the other a more flexible plan to suit the salary sacrifice arrangement.
Net pay arrangement vs relief at source
Different pension operators provide plans to collect pension in one of two ways. In this illustration, a staff member has other income equal to the personal allowance. All pay is therefore taxed at 20%. Gross pay is £31,136. Pensionable pay is £25,000.
|
Relief at source |
Net pay arrangement |
||
|
Taxable and pensionable pay |
25,000 |
Pensionable pay |
25,000 |
|
Tax @ 20% |
(5,000) |
Pension @ 5% |
(1,250) |
|
Pension @ 4% |
(1,000) |
Taxable pay |
23,750 |
|
Tax @ 20% |
(4,750) |
||
|
Take home pay |
19,000 |
Take home pay |
19,000 |
|
Pension contribution |
|||
|
From payslip |
1,000 |
From payslip |
1,250 |
|
From employer |
750 |
From employer |
750 |
|
Direct from HMRC |
250 |
Direct from HMRC |
Nil |
|
Total |
2,000 |
Total |
2,000 |
|
HMRC |
|||
|
Receive in tax |
5,000 |
Receive in tax |
4,750 |
|
Pay in pension |
(250) |
Pay in pension |
Nil |
|
Net |
4,750 |
Net |
4,750 |
The NiCable pay is the same figure of £25,000 in the above two examples. Furthering the example to a salary sacrifice scheme the NICable pay would be £23,750.
