Pensions Auto-Enrolment and Salary Sacrifice
Speed Read: Many employers remain unprepared for auto-enrolment and unaware of the effect it will have on their overall payroll costs. All employers will be required to have a qualifying pension scheme and contribute at least 3% of salary for all employees by 2014. Implementing salary sacrifice now is likely to create employer NIC savings to part fund the expected costs once auto-enrolment comes into force.
For a few years now, many corporate advisers have been aware of the major changes in pension schemes from 2012, however many employers are still unprepared. Although the reform will only take effect for larger employers in 2012, with smaller employers to follow in tranches up until the end of 2014, employers should be aware and begin to plan for the costs involved.
The changes will mean that employers will have to enrol their employees into an employer pension scheme within three months of joining on a permanent contract, and although the employee can opt out, hefty fines will be levied if an employer attempts to encourage employees to do so. In addition, a minimum employer contribution of 3% must be provided, with a minimum total contribution of 8%.
The cost for employers is likely to be substantial, even where an employer would normally open their pension scheme up to employees after 3 months and meet the minimum employer contribution; often apathy will mean that employees do not join the scheme. This will no longer happen, with the employee having to actively opt out of the scheme if they do not want contributions to be taken.
For employers without a current qualifying scheme, often SMEs, the effect of the reforms are likely to be greater, effectively adding an additional 3% to payroll costs each month in addition to the burden created for the finance team to manage the pension scheme.
Salary sacrifice has been used for a number of years for these purposes and is a generally accepted practice of providing low tax benefits to employees at nil cost to the employer. In order to ensure the scheme is compliant, the scheme must contractually reduce the employee’s salary.
One way to start part funding the additional costs is to use salary sacrifice. The regulations for the reform do not specify a minimum employee contribution, so if an employee reduces their gross salary in exchange for an employer contribution of equal value, this will create a saving in employee and employer National Insurance Contributions (NIC).
An employer can set up a salary sacrifice scheme now, provided employees are currently making pension contributions and begin stockpiling employer NIC savings to fund the expected cost of auto-enrolment, whilst employees gain a valuable benefit of saving employee NIC on their pension contributions, creating an increase in their take-home pay compared to current arrangements.
Worked Example
Employee Contribution Salary Sacrifice
Salary 25,000 25,000
Salary Sacrifice (1,250)
Gross Salary 25,000 23,750 Employee Contribution (1,250)
Income Tax (3,255) (3,255)
Employee NIC (2,133) (1,983)
Net Pay 18,362 18,512 Employer NIC (2,453) (2,280)
The example above shows the potential savings for a basic rate taxpayer, earning a basic salary of £25,000 and currently makes an employee pension contribution of 5%. Making the same contribution via salary sacrifice would give the employee an annual increase in take home pay of £150 and save his employer £173 in NIC.
For higher rate taxpayers, the employee NIC rate is lower so savings for employees are reduced but they will still have an increase in take home pay compared to an employee contribution whilst the employer continues to save at a of 13.8% on the employee’s sacrifice amount.
If you would like to discuss how salary sacrifice could work for your business, please contact Tom Ogden at togden@edge-tax.com or your usual contact.