How does salary sacrifice pension work?

Overview of Salary Sacrifice Pension

Salary sacrifice is a government-backed arrangement where an employee agrees to reduce their gross salary in exchange for their employer making an equivalent pension contribution directly. This is a tax-efficient way for both employers and employees to make pension contributions, as it reduces the amount of salary subject to income tax and National Insurance.

How Salary Sacrifice Works in Practice

1. The employee agrees to give up (sacrifice) a portion of their salary
2. The employer pays this sacrificed amount directly into the employee's pension
3. The employee's taxable income is reduced by the amount sacrificed
4. Both employer and employee pay lower National Insurance contributions

Example Calculation

For an employee earning £50,000 annually who sacrifices 5% (£2,500) to their pension:

Before Salary Sacrifice:

• Employee contributes 5% (£2,500) from post-tax salary to pension
• Employer contributes 3% (£1,500) to pension
• Total pension contribution: £4,000
• Employee's PAYE and NI bill: £9,980.40
• Net annual pay after pension and tax: £37,519.60
• Employer's NI bill: £5,644.20

After Salary Sacrifice:

• Employee's new gross salary: £47,500 (original £50,000 minus £2,500 sacrifice)
• Employer contributes total of £4,000 (£2,500 sacrificed amount plus £1,500 original employer contribution)
• Employee's PAYE and NI bill: £9,780.40 (reduced)
• Net annual pay after tax: £37,719.60 (£200 more)
• Employer's NI bill: £5,299.20 (£345 less)

Employer Benefits

• Reduced National Insurance contributions
• Attraction and retention of talent through enhanced benefits package
• Positive company image and employee goodwill
• Potential to reinvest NI savings into the business or further enhance pension contributions

Employee Benefits

• Increased take-home pay due to lower National Insurance contributions
• Potential for greater overall pension contributions
• Tax efficiency for higher-rate taxpayers

Limitations and Considerations

• Cannot reduce salary below National Minimum Wage/National Living Wage
• May affect salary-linked benefits or credit applications
• Could potentially reduce statutory maternity/paternity pay and other statutory benefits
• May impact mortgage applications as gross salary is reduced
• All employees must provide written consent to the arrangement

Implementation Requirements

• Employer must amend employment contracts to reflect the salary sacrifice arrangement
• Payroll systems must be configured to handle salary sacrifice correctly
• Proper documentation and employee communication is essential
• Some pension providers may charge for implementation

Setting Up Salary Sacrifice

1. Contact your payroll or pension provider to ensure they can facilitate salary sacrifice
2. Obtain employee consent through contract amendments or agreement letters
3. Update payroll systems to reflect the new arrangement
4. Document the changes appropriately for HMRC compliance

For detailed guidance on implementation or converting an existing pension scheme to salary sacrifice, contact us here