Could salary sacrifice be a solution

July 7th 2022

Several of your employees have been affected by the recent NI rate increase. As their employer, they have asked if there is anything that you can do to increase their pay packages. Could salary sacrifice be an unexpected solution? Brona MacDougall provides the answer.

The tax advantages of some salary sacrifice schemes for employees, for example those involving company cars, which were in place before April 2017 finally came to an end in April 2021. A small number of other schemes can still be used to obtain tax savings but they are of limited application because the benefits they provide won’t suit all, e.g. provision of childcare. However, there’s one type of salary sacrifice that can be used by most employees.

Pension contributions
Salary sacrifice this involves an employee giving up some of their salary in exchange for their employer paying into a pension scheme isn’t subject to the restrictions imposed by HMRC in April 2017. The main reason for this is that even before then it probably didn’t result in any tax savings.

Whilst there’s no tax advantage to pension contribution salary sacrifice schemes, they can still be used to reduce NI contributions for both clients and their employees. This has just become more valuable following the rate increases from April 2022.

Pension-related salary sacrifice
What makes schemes involving pension contributions more useful than other salary sacrifice arrangements is that most employees either belong to a workplace pension or contribute to a personal pension plan of their own. In either case as an employer your client can use this to offer a pay rise to workers in the form of extra pension contributions at no cost.

Despite making losses over the last year because of tough trading conditions, Smith Ltd wants to reward its employees. It can do this at zero cost by entering into a salary sacrifice agreement to pay its employees’ workplace pension contributions.

John’s annual salary is £48,000 and his workplace pension contributions are £3,000. That’s £250 per month, which after basic rate tax relief is £200. Smith deducts this from John’s salary. It agrees to pay his pension contributions (plus a little extra) in exchange for him giving up salary of £3,529 per year. While John is giving up more salary than he saves in pension contributions, he will receive the same net pay because his NI contributions are lower.

At the same time, John’s pension fund is better off because Smith pays the £3,529 it saves by paying him less salary along with the £531 employers’ NI it saves. A zero cost to Smith Ltd and John, his pension fund is boosted by £4,060 per year. The increase of £1,060 is equivalent to a 2.21% pay rise.

A pension-related salary sacrifice produces better results for employees whose earnings are £50,270 (the NI upper earnings limit) or less than those with higher earnings. But in both cases, there’s an advantage.

The example above represents the “net zero” position for the employer. Of course, they may wish to share the NI savings with the employee and so set the sacrifice at a lower amount.

A salary sacrifice arrangement linked to pension contributions can increase an employee’s net pay by saving NI contributions. This, along with the NI savings the employer makes, can be used to increase the amount going into their employees’ pensions. For example, this could be equivalent to giving them a 2.21% pay rise.

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