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Case study: Auto-enrolment and salary sacrifice

Colin Batchelor Legal & General

There has been much debate about the use of salary sacrifice and its interaction with the requirements of auto enrolment. HMRC has recently clarified some of the finer detail regarding those employees who choose to opt-out.

In the regulations for auto enrolment contained in the Pensions Act 2008 there is no reference to salary sacrifice; there is only reference to the point that restrictions to joining cannot be put in place.

Making salary sacrifice the sole mechanism to achieve auto enrolment will be deemed a restriction. But that’s not to say that salary sacrifice cannot be used, indeed given the potential savings for both employee and employer there is merit in its use.

We have to consider salary sacrifice as a method of voluntarily joining the pension scheme. Both the employer and employee agree to an amendment to the terms and conditions of the employee’s contract of employment. The employee agrees to forego an amount of salary in return for a non-cash benefit, in this case a contribution to their pension arrangement.

If the employee is not happy to join on this basis they do not have to. However, at the employee’s auto enrolment date their employer must auto enrol them into a qualifying pension scheme. It may be sensible for an employer to use a waiting period to inform their employee of how they propose to enrol them into the pension scheme.

Case study:

Rufus Leaking runs a DIY company and he has identified that his staging date to auto enrol all eligible jobholders will be 1 May 2013. Rufus already has a good quality scheme in place which operates on a salary sacrifice basis; the employee sacrifice’s 5% of their salary and Rufus matches that 5 per cent and is generous enough to reinvest 50 per cent of his National Insurance saving.

If we look at Dennis Racket, who earns £25,000 a year and is aged 30. The following table sets out the difference to Dennis’s take home pay should he become a member of the pension scheme. If Dennis were to join the scheme on a salary sacrifice basis Rufus saves £172.50 in National Insurance, however he is willing to pass 50 per cent of this saving across(£86.25) and add it to Dennis’s pension contribution. Dennis is also saving National Insurance (£150.00).

  No Pension contribution Pension contribution but not on a salary sacrifice basis Pension contribution on salary sacrifice basis


£25,000.00 £25,000.00 £23,750.00
Personal allowance £8,105.00 £8,105.00 £8,105.00
Income tax £3,379.00 £3,129.00 £3,129.00
Employee National Insurance £2,087.40 £2,087.40 £1,937.40
Employer National Insurance £2,416.66 £2,416.66 £2,244.16
Net salary £19,533.60 £18,533.60 £18,683.60
Pension contribution Nil £2,500 £2,586.25

In the run up to the auto enrolment staging date Rufus begins a communication campaign to explain that he is legally obliged to enrol eligible employees into his pension scheme. Rufus also decides that he wishes to continue to operate membership on a salary sacrifice basis.

With the staging date due on 1 May 2013 Rufus decides that he will use a waiting period to help. He writes to all of those affected and informs them that he will put them into the pension scheme on 1 August 2013; this will be achieved on a salary sacrifice basis. Rufus sets out the benefits that can be gained by using a salary sacrifice method and that this also means a change to the employee’s contract of employment.

He knows that he cannot force his employees to join on a salary sacrifice basis so he gives them the opportunity during the waiting period to state that they do not wish to join the scheme on a salary sacrifice basis. He informs them that should they decline the salary sacrifice method of joining that he will then have a legal obligation to automatically enrol them into his pension scheme on 1 August 2013 on a non-salary sacrifice basis.

As we have explained in the example above the salary sacrifice arrangement requires a variation in the terms and conditions of the employee’s contract of employment. The employee is agreeing to forego salary in return for a non-cash benefit (in this case a pension contribution). Normally such an arrangement remains in place for a set period however HMRC do consider certain “lifestyle changes” mean that the arrangement could end earlier than expected – such lifestyle changes are not defined by HMRC but generally would include: redundancy of a partner, pregnancy of an employee or their partner, marriage and divorce.

One of the issues troubling employers was the interaction of using salary sacrifice with auto enrolment. Should an employee choose to opt out what would be the consequences? HMRC has now clarified that where a salary sacrifice scheme is to be used in conjunction with a workplace pension scheme it will not be necessary to stipulate a period for which the agreement must apply for.

In simple terms this means that where an employee decides to opt-out of the workplace pension scheme the employee’s salary would be returned to their pre-sacrificed amount. If the employee opted out after the payroll cycle had been run the employer should return the amount deducted back to the employee through the payroll system so that the appropriate tax and NI are accounted for.

This leads us on to another question facing employers. At what point should they offer the option of contributing on a salary sacrifice basis?

Where the employer decides to operate salary sacrifice at outset they need to understand that some of their employees will choose to opt-out immediately. The employer will then need to unravel the salary sacrifice arrangement and return the employee to their pre-sacrificed salary. If the opt-out rate is high this could create a great deal of extra administration for the employer.

The employer may therefore wish to delay offering salary sacrifice for a number of months. By doing so they will only be offering the opportunity to contribute on this basis to employees who have chosen to remain in the scheme; the numbers choosing to leave the scheme after the initial auto enrolment bulge will, I imagine, be significantly lower.

Indeed, until the option to facilitate short service refunds has been abolished (timetabled for 2014) an employer using a trust-based arrangement may prefer to wait until the employee has achieved membership of the scheme of two years or more before offering salary sacrifice.

Colin Batchelor is Head of Pensions Technical at Legal & General Savings


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There is one comment at the moment, we would love to hear your opinion too.

  1. Nicholas Mendham 2nd July 2015 at 6:06 pm

    This article was written in August 2012, have the HMRC rules changed between then and now (July 2015)? What if salary sacrifice is just an option, not the principal method of contribution to the pension scheme?

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