Are you making the most of the cost savings in NIC available for both employers and employees?
In the current economic climate of tough trading conditions and nil or even negative pay awards, employers are having to achieve savings in all aspects of their business, whilst also seeking to motivate and retain staff. Utilising 'salary exchange' or 'salary sacrifice' for pension contributions can produce a win:win, with both the employer and employee able to achieve considerable savings in national insurance contributions.
What is salary sacrifice?
A salary sacrifice happens when an employee gives up the right to part of the cash remuneration due under his or her contract of employment. Usually, the sacrifice is made in return for the employer's agreement to provide the employee with some form of non-cash benefit. The sacrifice is achieved by varying the employee's terms and conditions of employment relating to remuneration. For example, an employee's current contract provides for cash remuneration of £40,000 a year with no benefits. The employee agrees with the employer that for the future the employee will be paid cash remuneration of £38,800 a year and an employer pension contribution of £1200 per annum. This would be referred to as a salary sacrifice.
A salary sacrifice replaces cash with a benefit. Examples of the type of benefit received instead of money include:
- An employer contributing to a registered pension scheme: as the scheme is approved the employer’s contribution is not a chargeable benefit.
- Childcare vouchers: since April 2005 there has been limited exemption from tax and national insurance contributions (NIC).
- Workplace nurseries: these are exempt from tax and NIC
- Other employer provided childcare
Salary sacrifice is now commonly used by employers and employees to take advantage of the exemption from tax and/or NIC on certain benefits. It is important to recognise that employers and employees have the right to arrange the terms and conditions of their employment and to enjoy the statutory tax and NIC treatment that applies to each element in the remuneration package. Arrangements, which are genuinely designed to make use of these exemptions, will not be regarded by HM Revenue and Customs (HMRC) as avoidance.
In relation to NIC, employees in a contracted in scheme, who are earning up to the Upper Earnings Limit (UEL) of £43,888 in 2009/10 will save 11% of any salary sacrificed in return for a pension contribution. For someone earning above the UEL, and earnings remain above the UEL after any salary sacrifice, they will save 1% of the amount sacrificed.
The table below illustrates the savings that employers and employees can achieve through salary sacrifice.
SAVINGS IN NATIONAL INSURANCE |
||
Example based on National Insurance (NI) contribution rates for the 2009/10 tax year. Contracted in scheme. |
||
|
Current position |
After salary conversion |
|
£ |
£ |
Annual salary |
35000 |
33250 |
5% member contribution |
1750 |
0 |
Taxable salary |
33250 |
33250 |
Salary subject to NI |
29280 |
27530 |
Member’s National Insurance |
3221 |
3028 |
Members NI saving |
|
193 |
|
||
Employer’s National Insurance |
3748 |
3524 |
Employer’s NI saving |
|
224 |
|
||
Notes: |
||
Employee NI rate |
Contracted in |
11.0% |
Employer NI rate |
Contracted in |
12.8% |
Nil band of earnings for National Insurance |
£5720 |
|
Higher paid employees |
Employer savings are unaffected but personal savings diminish for higher paid employees as employee NI rate is only 1% on earnings above £43,888 |
|
Possible Impediments
There are a number of issues that need to be considered when looking at salary sacrifice, which may act as possible impediments to implementing an arrangement. These include the following:
- Interaction with employee benefits;
- National Minimum Wage; and
- Entitlement to Basic State Pension and/or other earnings-related State benefits;
Employee Benefits
Where other salary-related benefits are provided for employees, these can be protected by the use of a ‘reference salary’. This is simply a mechanism whereby the pre-sacrifice salary continues to be recorded and used in determining entitlement to benefits. It is common to use the same reference salary for the purposes of salary reviews and bonus calculations as well.
One issue that is often raised by employees in relation to salary sacrifice is the potential impact on credit applications and, in particular mortgages. Most mortgage lenders are now familiar with salary sacrifice arrangements and are willing to accept confirmation from the employer of the higher salary. It would however, be important to cover this as part of any communication program.
National Minimum Wage Implications
HMRC requirements for salary sacrifice include a proviso that salary must not be reduced below the level of the national minimum wage post sacrifice.
Interaction with Basic State Pension and/or earnings-related State Benefits
Basic State Pension (BSP) should be unaffected by salary sacrifice as long as members continue to earn above the Lower Earnings Limit (LEL) (£95pw, £4,940 pa for 2009/10) throughout the year.
State Second Pension (S2P) will be affected as it is derived from earnings between the LEL and Upper Earnings Limit (UEL). However, anyone earning less than £13,500 (2008/09 tax year) is treated as earning £13,500 as long as they earned more than £4,680.
Therefore, if gross earnings are reduced by virtue of a salary sacrifice arrangement, the percentage of S2P pension built up may similarly reduce. Although the S2P pension would reduce under salary sacrifice, this is balanced by a corresponding reduction in National Insurance contributions.
However, if an individuals post sacrifice salary is still above the UEL, there will be no reduction in S2P. Similarly if their salary is less than £13,500 there will be no adverse impact since they will be assumed to earn at least this level for the purposes of S2P accrual.
Requirements for an effective sacrifice
For salary sacrifice to be effective an individual must give up his/her entitlement to future salary before it is treated as received for employment income purposes. Once earnings have been “received” for employment income purposes they are taxable even if a payment is not actually paid over.
In order to ensure that HMRC are satisfied that the change to an employment contract is valid, employees will be required to remain in the salary sacrifice arrangement for a minimum period, normally 12 months from commencement. Thereafter they will be able, on an annual basis, to review their decision. Additionally, they will be able to opt-out within a 12-month period if they undergo a ‘lifestyle’ event. A lifestyle event is a major change to personal circumstances. Some examples of what might constitute a lifestyle event include; notification/commencement of maternity leave, birth of a child and commencement of a period of long term absence or secondment.
It is important to note that HMRC cannot and will not comment on how to set up a salary sacrifice arrangement or whether draft documentation will achieve a successful salary sacrifice. HMRC’s only interest is in determining how the tax and NICs legislation applies to the various elements of the employee’s remuneration package. As such, HMRC will only comment on proposed transactions in a very limited range of circumstances and these limited circumstances do not apply in a case of a proposed salary sacrifice.
In addition, there is no legal requirement for the Company to inform HMRC that a salary sacrifice arrangement has been set up. In our experience however, many employers will wish to do so for reassurance that they are accounting for the correct amount of Income Tax and NIC. If HMRC approval is sought it would be on the strict understanding that this will cease to apply if there is a significant change in the terms, conditions or operation of the scheme.
How can we help you?
Gissings has advised many organisations, helping them to correctly and smoothly introduce salary sacrifice arrangements, and thereby achieve annual savings of many thousands of pounds. Our approach is rigorous and well structured, ensuring that employers benefit from our experience and expertise in this area. A brief overview of the key stages is as follows:
Phase One: Feasibility study
We will undertake an investigation and then produce a report identifying the cost savings that can be achieved by the introduction of salary conversion. We will also identify possible impediments to implementation.
During this stage we will examine the demographic profile of the members and will make an assessment of the impact that salary conversion will have:
- on the other salary related benefits provided for employees, and
- on State benefits and statutory entitlements
and we will make recommendations to protect the members salary related benefits so far as is possible.
Phase Two: Review of impediments
We will undertake an analysis of any impediments identified in Phase One and provide specific advice as to how these can be overcome.
Phase Three: Implementation plan
We will provide an implementation plan together with an initial draft of the communication to members and advice in relation to the communication of the proposed changes.
Phase Four: Implementation
This phase covers the implementation on the basis of the plan agreed in Phase Three.
If your organisation is not already using salary sacrifice, don't miss out. Let Gissings show you the way to making considerable cost savings. Call us today.
Tony Barnard, Technical Consultant, Gissings Consultancy Services Limited
www.gissings.co.uk
