There is much speculation that the government could pull the plug on salary sacrifice pension arrangements particularly as personal accounts draw nearer, but how likely is this to happen, asks Sonia Speedy
Changing national insurance (NI) thresholds are set to boost the attractiveness of pension schemes offered through salary sacrifice arrangements next year, but these schemes still have challenges to face as the government moves towards the introduction of personal accounts in 2012.
Salary sacrifice works on the basis that employees give up the right to a portion of their gross salary in return for this amount going directly into their pension. The employee saves on tax and NI, while employers benefit from NI savings of up to 12.8%. Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “It’s a more efficient way to save for retirement.”
Financial advisers and pension specialists alike extol the virtues of the schemes. Ian Hopkinson, head of tax for people services at KPMG, suggests it is almost negligent of employers not to structure pension schemes around salary sacrifice arrangements, unless there is a good reason not to.
Andrew Tully, marketing technical manager at Standard Life, says salary sacrifice will become even more attractive from April 2008 due to significant increases in the ceiling up to which employees pay 11% NI. Currently the relevant earnings ceiling is set at £34,840, over which employees only pay 1% NI, but this threshold is to increase by £3,900 over and above the normal level of increase, which is generally in line with inflation. “That’s quite a bit of extra tax that people are going to be paying. You can use salary sacrifice for your pension contributions and that can offset a lot of that NI increase,” says Tully.
In recent years, however, there has been much speculation that the government will remove the tax break on pensions offered through salary sacrifice. This has intensified since personal accounts were first announced.
“I think it’s possible that they could look to either close or limit salary sacrifice in the run up to 2012, particularly after the big uptake in the number of employers using it,” he says.
But, McPhail disagrees: “I don’t think that the introduction of personal accounts will herald the end of salary sacrifice. If anything, for some segments of the market it may give the mechanism some momentum.”
The planned introduction of personal accounts in 2012, could polarise the pensions market, encouraging those employers looking for the cheapest and most straightforward pension option to default to personal accounts. Other employers may choose to use their pension schemes as a point of differentiation, putting greater effort into communicating perks and widening the use of mechanisms such as salary sacrifice.
Andrew Cheseldine, defined contribution specialist at Hewitt Associates, says: “Most people that [will] get into personal accounts just want a really simple deal. So salary sacrifice could be one of the good differentiators between occupational pensions and good quality contract-based pensions such as personal pensions and the like, and personal accounts.”
But salary sacrifice does have its pitfalls. While possible to work around, most downsides are related to the fact that an employee’s salary is technically reduced, creating flow-on effects for earnings-related payments such as death-in-service benefits, redundancy, maternity and state benefits, as well as getting a mortgage. Furthermore, salary sacrifice arrangements cannot be used for those on the minimum wage as it means they are technically earning less than the minimum amount. Public sector pension schemes can also face difficulties. Many are final salary schemes and the benefits can be less obvious for employers, while there could also be potential for union opposition.
Industry opinion is now divided on HM Revenue & Customs’ (HMRC) on-going tolerance for pensions salary sacrifice. Such schemes may be safe because they encourage employees to save for retirement with employers them helping to do so. However, Iain Henshall, principal consultant at Towry Law, believes there can be no certainty of a government u-turn, while others question its “wherewithal” to bring in personal accounts.
Cheseldine believes the take-up of salary sacrifice is rising though. “Anecdotally, there is much more interest from employers in it, because everyone’s looking to get the greatest efficiency out of the money they currently spend on pensions,” he says.
While the merit of salary sacrifice arrangements for pensions is clear, whether or not it is here to stay still hinges with HMRC EBIf you read nothing else read this…
If you read nothing else read this…
- Salary sacrificed pension arrangements offer significant cost savings for both employers and employees.
- Such schemes are set to become more attractive next April due to changing national insurance thresholds.
- Experts believe personal accounts are unlikely to have a negative effect on salary sacrifice and may give it a boost.
- But there is some concern that HM Revenue and Customs may move to close, or limit, salary sacrifice in the run-up to 2012.