Salary Sacrifice Arrangement, Explained

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When it comes to an employee’s pension, forethought and planning can be powerful tools. But there are other cost-effective ways to plan employee pensions, including what’s known as a ‘salary sacrifice’ arrangement or scheme. For those wanting to strike a more even balance between immediate job-related benefits and long-term pensionable pay, there are schemes available to facilitate this change.

Before committing to this kind of contractual change, it’s helpful to have guidance on the implications of a salary sacrifice scheme, and what it means for how you pay your employees.

What is a Salary Sacrifice Arrangement?

When it comes to pensions, it’s always important to weigh the long-term rewards against any immediate benefits. Your employees may be motivated by job-related compensation, but pension planning can be too easily overlooked on their part, which is why the Pensions Act (2008) was drafted to include ‘automatic enrolment’ schemes. This is to ensure that work is still rewarding long into the future.

A salary sacrifice scheme describes an arrangement whereby an employee agrees to exchange a part of their pensionable pay for non-cash benefits.

The UK government understands salary sacrifice as follows:

“an agreement to reduce an employee’s entitlements to cash pay, usually in return for a non-cash benefit.”

So that they manage expectations, the employee and employer should agree on this arrangement and record any changes in an employee’s employment contract. It’s advisable to consider all benefits of this kind of arrangement and the impact this may have on an employee’s pension long into the future. 

Employers considering this scheme should understand how to remain compliant with PAYE. If an agreement is reached, and an employer negotiates a salary sacrifice arrangement, then an employee’s wages may not be reduced below the National Minimum Wage (NMW) rate. When calculating this benefit, and managing your payroll, employers must consider the effects of salary sacrifice on NMW and any further deductions.

Changing a Salary Sacrifice Arrangement

If an employee requests to opt out of these salary schemes voluntarily, you must record any changes in their employment contract. After reflecting its terms in a contract, a compliant salary sacrifice arrangement becomes official. The employer and employee both have this opportunity to clarify what the entitlements are, including non-cash and cash benefits.

In certain scenarios, alterations to salary sacrifice arrangements may be triggered by lifestyle changes. This is important where any changes affect an employee’s financial wellbeing. As a result, it’s common for these arrangements to have an opt-out in the case of a significant lifestyle change.

Examples of these changes include:

• Coronavirus
• Marriage
• Divorce
• Pregnancy

Salary sacrifice arrangements are, typically, in place for 12 months. This can change, as mentioned, if a lifestyle event necessitates a review of benefits. Changes to this scheme are always dependant on reaching a mutual arrangement and can be removed or renewed as long as its reflected in an employment contract.

It’s important to understand how an employee is using the salary sacrifice arrangement, because it impacts tax expectations. If an employee, for example, casually swaps between cash entitlements and non-cash benefits, then tax and National Insurance contribution advantages will not apply.

Examples of Salary Sacrifice Arrangements

Here are some common examples of available salary sacrifice arrangements found in workplaces across the country:

• Childcare vouchers
• Personal learning opportunities
• Car parking
• Home computers
• Nursery access

Whilst there are more entitlements available, employers and employees should agree on the cash value of any benefits, ensuring that these are worth enough to compensate for the loss of income.

Payroll Implications of a Salary Sacrifice Arrangement

The salary sacrifice value will reduce the earnings used to determine (or calculate) tax and NI contributions payable by an employee. An employer is responsible for deducting tax and National Insurance contributions for the cash and non-cash benefits provided to an employee, including those entitlements under a salary sacrifice scheme.

An employer needs to report the cash entitlements of an employee accurately through the PAYE system on their payroll.   

Calculating non-cash benefits

Firstly, employers need to determine the cash value of benefits on offer. You can benchmark this against the higher of two options:

• The amount of salary deducted
• Any earnings charge, according to benefit in kind rules

From April 6, 2017, the UK government removed tax and National Insurance advantages for salary sacrifice schemes (benefit in kind exemptions do not apply here). There are currently a few exceptions, including:

• If payments into pension schemes are increased
• An employer receiving advice on their pension
• Qualifying workplace childcare or nurseries (if an employer was enrolled prior to October 4, 2018)
• Cycle to work schemes, or equivalent

A few benefits were slowly phased out and these were valid until April 2021, including benefits for:

• School fees
• Living and accommodation
• Ultra-low car emissions (for cars where CO2 emission are below 75 g/km)

‘Final pay controls’ and penalties

According to HMRC, there are rules that prevent employers from raising an employee’s pensionable pay significantly before retirement. A ‘final pay control’ prevents employees from accruing unfair additional pension where they have not made the relevant contributions.

For an employer, this means that closing a salary sacrifice arrangement close to retirement can result in increased pensionable pay. Therefore, an employer can be charged with a penalty.

The Effects on Workplace Pension

Ultimately, an employer will decide on the impacts of a salary sacrifice scheme on existing workplace pension schemes. Employers are advised to review any changes to pension schemes with their provider, ensuring that changes remain compliant.

Whilst salary sacrifices can align with pension plans, it’s advisable to plan any changes with your provider and employees. This might, for example, include an employer opting to pay above the minimum pension contribution and the employee receiving a lower cash salary.

What Employers Should Consider 

Before opting into a scheme of this kind, consider the following:

• How important are the renewed arrangements to an employee – and does this impact their work, productivity, or engagement.
• How does the benefit compare to an employee securing the benefit through self-funding?
• How costly is the arrangement?
• How compliant is the arrangement?  

Use Staffology to Remain Compliant

Using our intuitive payroll software, Staffology can help your business set up a payroll solution that proactively manages your employees’ salaries – regardless of changes, amendments, or revisions. Whether an employee’s employment contract is renewed under salary sacrifice arrangement, or benefits are removed, you will need to rely on a payroll solution that flexibly adjusts and compliantly looks after your employees.

To find out more about Staffology and how our payroll can help your business, get in touch today.

Duane Jackson, February 16th, 2022

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