Pensions and Salary Sacrifice for lower-paid workers — is it time to look again?

If you use salary sacrifice with staff on or near the National Living Wage or, for younger staff and apprentices, the National Minimum Wage, you may need to look at whether this is still possible.

What is salary sacrifice?

Salary sacrifice, often used for pensions, means that staff (and indeed employers) can benefit from National Insurance contribution reductions and in some cases tax advantages while keeping the same amount of money going into the pension scheme. There can also sometimes be income tax savings, as well as allowing staff a little more in their pay packets. It’s normally a win-win as both employees and employers benefit.

It works by an employee agreeing to give up (i.e. sacrifice) some of their pay on a long-term basis. In exchange, the employer pays into a pension scheme the amount the employee has sacrificed, as well as its normal employer contribution.

Salary sacrifice has not been in the interests of or beneficial to lower paid staff, particularly if they work part-time, if they don’t receive enough pay to have to make National Insurance contributions. A reduced salary can also affect some state benefits.

What’s different now?

Now, there may be a wider problem for some employers and some staff. It’s a case of the law of unintended consequences.

NLW has increased over the last few years. Since April, it has been £11.44 an hour for workers aged 21 or over (this used to be aged 23). This means staff are paid more for the work they do. NMW runs at a lower level.

At the same time, the earnings threshold for automatically enrolling workers into a suitable pension scheme has remained at £10,000 per year (or the equivalent for weekly, fortnightly or monthly pay). This means that more staff must be automatically enrolled into a pension.

Setting aside increases in your payroll costs, this is generally a good thing. Higher wages help people in the current cost of living crisis, and increased enrolment into a pension scheme should mean that more people can save for a more comfortable retirement. And if some of the extra costs can be absorbed by using salary sacrifice to make pension contributions, then that surely is a good thing?

The problem is that a worker can’t agree to reduce their pay below the National Living Wage level, even in respect of salary sacrifice into a pension. The same is true for people who qualify for the National Minimum Wage. It’s perfectly fine to deduct the same level of direct contributions from salary to the pension scheme in the form of employer contributions, but you cannot reduce the salary itself.

This means that:

• you can’t use salary sacrifice to make pension contributions for staff who must be automatically enrolled into a pension, if using salary sacrifice would mean that their pay drops below NLW/NMW levels, unless you’re willing to pay staff more so that the actual take-home pay doesn’t drop below minimum levels.

If you currently use salary sacrifice as your default pension contribution route, then you should check to make sure you’re not reducing workers’ pay below minimum levels, particularly those at or close to NLW/NMW, and especially if you have recently enrolled them into a pension scheme for the first time.

What can we do about it?

The main options are to stop using salary sacrifice for lower paid staff, or to increase pay so that even after sacrifice staff are not below whichever minimum pay level applies.

Weightmans’ pensions and employment teams can help with both, including with working out how many staff, or grades of staff, may be affected, and how to amend contracts of employment. We have guidance notes for your HR teams, presentations and communications for staff, and contractual change documentation, which we can tailor to your needs.