Salary sacrifice for pensions explained

Salary sacrifice pensions are a tax efficient way for employers and employees to pay into a workplace pension scheme. They can help employees increase their take home pay and help employers lower their National Insurance contributions.

What is salary sacrifice?

Salary sacrifice is a government backed scheme to help employers and their workers save on tax. An employee agrees, with their employer, to give up part of their salary in exchange for non-cash benefits. The benefits are not subject to income tax or National Insurance contributions (NICs) so their taxable salary is reduced.

What is a salary sacrifice pension?

In a salary sacrifice arrangement, employees agree to give up a part of their earnings, reducing their overall salaries. The employer agrees to pay these ‘sacrificed’ earnings directly into employees workplace pensions.

By reducing salaries, both employees and employers are subject to lower National Insurance contributions. This means they pay less tax and get to keep more of what they earn overall.

How does it work?

Let's say you offer a salary sacrifice pension to your employees and one of your employees earns £50,000 a year.

• The employee decides to sacrifice £2,500 of their salary to their pension.
• The employer contributes this £2,500 to their pension fund directly.
• The employee would not pay tax on the pension contribution, therefore their taxable income would be reduced to £47,500.
• This can lower the employee's tax bill by hundreds of pounds each year.

Salary sacrifice example

Here's an example of how a salary sacrifice scheme works for an employee who earns £50,000 a year.

Before salary sacrifice

• The employee contributes 5%, £2,500, of their earnings into their workplace pension.
• The employer contributes a further 3%, £1,500.
• Therefore total pension contributions are £4,000.
• The employee's PAYE and National Insurance tax bill is £11,477.60.
• After pension contributions and tax deductions the employee's net annual pay is £36,022.40.
• The employer's National Insurance tax bill is £5,644.20.

After salary sacrifice

• The employee earns £47,500 a year, sacrificing £2,500, or 5%, of their salary.
• The employer contributes the £2,500 employee sacrifice as well as the previous £1,500 employer contribution.
• Therefore total pension contributions remain £4,000.
• The employee's PAYE and National Insurance tax bill is £11,177.60.
• After pension contributions and tax deductions the employee's net annual pay is £36,322.40, that's £300 more.
• The employer's National Insurance tax bill is £5,299.20, that's £345 less.

Employer National Insurance savings

The savings scale up with employee headcount and can help businesses save money on their National Insurance bill.

Based on an average salary of £50,000 with each employee sacrificing the legal minimum contribution of 5% the savings are:

• Businesses with 50 employees could save £17,250 each year.
• Businesses with 100 employees could save £34,500 each year.
• Businesses with 250 employees could save £86,250 each year.

Find out how much your business could save on National Insurance contributions using our salary sacrifice calculator. Simply enter your number of employees and average employee salary to get a result

What are the employer benefits?

There are many benefits to offering a salary sacrifice pension, including:

• Reduced National Insurance contributions: By reducing taxable income, employers are required to pay less in National Insurance contributions. Employers can choose to strengthen the company’s net profits or reinvest the money they’ve saved back into the business.
• Attract and retain the best talent: A salary sacrifice pension is an important part of a strong benefits package. In a competitive job market boosting take home pay or pension contributions is key to recruiting and retaining high performing employees.
• Positive company image: Offering a salary sacrifice pension demonstrates an employers commitment to the financial well-being of their employees. This can result in positive reviews on platforms such as Glassdoor and LinkedIn.

What are the employee benefits?

Offering a salary sacrifice pension can provide significant benefits for employees as well. Some of the benefits include:

• Increased take home pay. Employees will see an increase in their take-home pay due to the tax savings from lower National Insurance contributions.
• Greater pension contributions. Employees can choose to add their additional take home pay to their pension pot. Employers may choose to add their National Insurance savings to their employees pensions.

What are the drawbacks?

Salary sacrifice can have an impact on anything that is linked to an employee’s salary. Here are a few things that may affect your decision to switch to a salary sacrifice scheme.

• Restrictions on low income earners. Employers aren't able to use salary sacrifice when it would reduce an employee’s earnings under the national minimum wage.
• Affects on salary based benefits. Salary sacrifice can affect employees entitlement to earnings related benefits. This includes things like life insurance or loan applications. Typically this can be resolved by explaining the situation to the lender.
• Potential maternity pay reduction. Typically statutory maternity pay is calculated based on average weekly earnings so could be reduced if your overall salary is reduced.

Setting up a salary sacrifice pension

Setting up a salary sacrifice pension can be straightforward if your existing provider already provides the option:

• First, employers should contact their payroll or pension provider. Employers should make sure they can facilitate salary sacrifice for their workplace pension scheme.
• Employers will need employees’ permission before entering them into a salary sacrifice scheme. Employees will need to agree to the change in their contract or through an agreement letter.
• Manage opt-outs for employees that don’t agree to salary sacrifice. Employers will need to pay these employees’ pension contributions as previously set up.

If the company’s existing pension scheme does not offer pensions with salary sacrifice there are a few options.

• Speak to a pension specialist such as a Financial Adviser or an accountancy firm. This is a common route for employers to get straight-talking advice from an expert.
• Contact another pension provider. Many workplace pension providers offer salary sacrifice consultations as part of their service. There's often a fee for this service, however Penfold's workplace pension offers free salary sacrifice consultation and implementation.

How Penfold can help

Offering a pension with salary sacrifice can provide significant benefits to both employers and employees.

Penfold's tech-first workplace pension makes it easy for employers to set up or convert to a salary sacrifice pension.

Speak to a Penfold salary sacrifice expert. A member of our team will explain how to save money with tax efficient pension contributions at your business.