Salary sacrifice on pensions

Good admin systems are vital for employers introducing salary sacrifice on pensions, says Ceri Jones

Article in full

If you read nothing else, read this …

• Salary sacrifice pensions admin will be straightforward if systems are robust.
• Carrying out a feasibility study will highlight the impact of reducing pay on benefits such as overtime pay and death-in-service arrangements.
• Whether employers need to replace their admin system will depend on the scale and complexity of existing and new pensions arrangements.

Many employers are now looking to offer pension schemes through salary sacrifice arrangements. In simple terms, these enable employees to replace their regular pension contributions with an equal amount deducted from their pre-tax contractual salary.

As the employee then effectively receives a reduced salary, both they and their employer are liable for lower Class1 National Insurance (NI) contributions, which equates to an annual saving for the employer of 12.8%, and there are tax savings for employees because the sacrifice is made from their gross salary.

When looking to implement such an arrangement, employers need to first ensure that their pensions admin systems are robust. According to David Daly, partner in the employer’s advisory department at accountancy firm Horwath Clark Whitehill, many firms fail to do so.

“There has been a tendency for salary sacrifice to be informal and flexible, but the arrangement has to be permanent. The first thing HM Revenue & Customs (HMRC) will look for is employment contracts and documentation,” he says.

Employers need to check all pay-related benefits such as overtime payments, life insurance, salary increments, and final salary pension benefits to ensure these are not reduced by being calculated according to employees’ new net salary. Instead, these benefits must be calculated by reference to the notional salary that employees would have received had salary sacrifice not taken place.

Putting a pension plan into a salary sacrifice structure also defines a scheme as non-contributory. As the employee technically hasn’t made any contributions, this affects death-in-service benefits and refunds for early scheme leavers. Employers typically commit to pay the equivalent where necessary.

Whether an employer will need to consider replacing their pensions admin system will depend on the scale and complexity of both the existing and new arrangements. Smaller firms may be able to handle a limited scheme manually. Horwath Clark Whitehill, for example, does this for its own 500 employees.

Richard Stewart, director at benefits provider Redbourne, says: “Most modern systems are easy to change and can accommodate a notional pre-sacrifice salary. But there is still a lot of old-fashioned IT out there, [so] bolting salary sacrifice onto old processes can be problematical.”

Nick Phizackerley, principal at actuary firm Lane Clark & Peacock, adds: “The truth is that if you get it right in payroll, then all you’re doing is passing on an earnings definition. There’s little impact on pensions administration, but if it is broken in payroll, that will create real problems. One very big retailer’s payroll system, for example, just could not add any additional columns for the extra data.”

A common mistake is not thoroughly reviewing HR processes. Tony Clare, pensions partner at professional services firm Deloitte, says: “There is a danger in thinking it is just a pensions and communications issue, and paying less attention to payroll and HR processes. Clients’ admin systems need to be looked at holistically.”

†