What is salary sacrifice?
A salary sacrifice happens when an employee gives up the right to receive part of their salary due under their contract of employment, usually in return for their employers agreement to provide them with some form of non-cash benefit, e.g. childcare vouchers. When an employee agrees to a salary sacrifice in return for a non-cash benefit, they give up their right to future cash remuneration. When entering into a salary sacrifice arrangement the employee needs to understand what the sacrifice will mean in practical terms, as the reduction in pay may effect the following:
- Their future right to the original (higher) salary
- Any pension scheme being contributed to
- Entitlement to Working Tax Credit or Child Tax Credit
- Entitlement to State Pension or other benefits such as Statutory Maternity Pay
- Credit rating
- Mortgage applications
- Death in service benefits
- Pay increases, overtime rates, bonuses, etc
In order to safeguard the above, it is advisable that a written agreement is obtained stating that the figure used should be the gross pay (plus any salary sacrifice element) and that payslips should also show this.
If the salary sacrifice does not take the employee's salary below the Lower Earnings Limit (LEL) for National Insurance (NI) then entitlement to benefits will not be affected, although entitlement to State Second Pension (S2P) may well be reduced if the salary sacrifice reduces their annual salary to between the LEL and Upper Earnings Limit (UEL).
When setting up a salary sacrifice scheme, an employer needs to consider the following:
- It will be necessary to change the employee's terms and conditions of employment if they decide to take advantage of the salary sacrifice scheme
- A salary sacrifice must not take an employee's salary below the national minimum wage level
- The effect if an employee takes multiple sacrifices
- The effect of a salary sacrifice on other benefits, e.g. life assurance
- The need to keep HMRC informed of the scheme and the new contractual arrangements
What is a smart pension?
A 'smart pension' is a type of salary sacrifice where an employee's salary is reduced by the amount of their pension contribution, and instead this is paid directly by the employer. The reason for this is that both the employee and employer will benefit from the reduced NI contributions on the lower salary. This can mean that the employee's take-home pay may be increased as compared to the pre-sacrifice situation, and the employer may well add the savings in NI contributions into the pension fund. With the cost of pensions rising, this can be a significant contribution to an employee's pension.
Pip Trowles
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