More and more businesses are using salary sacrifice to help employees boost their pensions – and it’s a great idea, especially as more people live longer lives and need to prepare for a fulfilling retirement. In our recent blog ‘What you need to know about salary sacrifice pensions’, I discussed the beneficial role it can play.
But even good ideas, like salary sacrifice, can come at a price if you’re not careful.
Why is there a risk with salary sacrifice?
Salary sacrifice is as it sounds: it is about giving up some of your wages in return for a benefit. However, because that means the amount of taxable pay goes down, this drop in money can turn out to be small. Some even see a tick upward because of this math.
As we’ve alluded to earlier, the most common use for salary sacrifice is pensions.
Why is this often the case? The reality is many people have not had a clear “run” at a pension. Indeed, the concept of auto-enrolment only came into force about ten years ago. For many people since then, their pension and its benefits have come into sharp focus – especially as new technology allows you to see how it is building up… or not, as the case may be.
For those up against the clock, salary sacrifice is a good way to put things right for their retirement.
But it does mean your salary drops on paper; anything contingent on this can drop as well. This can include:
- Pay increases
- Redundancy pay
- Overtime
- Life insurance
- Borrowing ability
Some of these potential problems might have an easy fix. For example, if a company calculates overtime and pay rises from the original salary, rather than after “sacrifice”, then recipients might feel that the outcome is fairer.
Meanwhile, some employers offer a letter as a reference for those looking to borrow money, so that salary sacrifice calculations do not impact the outcome of agreements like mortgages. It is worth remembering, however, that the decision to take an original “pre-sacrifice” salary into account is up to the lender.
But when post-sacrifice numbers have to be taken into account no matter what, there’s little that can be done.
Nightmare scenario one – missing out on entitlements
Who is affected? The employee
The lower earnings limit, currently set at £123 a week, is massively important to an employee. It decides entitlement to National Insurance contributions. Anything over the lower limit means you are entitled to get the benefit of National Insurance contributions against your name – with no payments on your part until you reach a primary threshold of £242 per week.
This limit can also affect other entitlements, like sick pay.
What can go wrong?
Alan has worked part-time at an independent record shop for just under a year. He realises that he can get a bike, to cycle to work, through a salary sacrifice scheme.
Before he takes the benefit, he is at the lower earnings limit, earning £123 every week. When he takes the benefit, his money drops below this level. Two things happen: although he is meant to have started his working life, Alan is unwittingly making no contribution to his state pension, which requires 30 years of National Insurance payments.
The other, more immediate issue is that shortly after undertaking the salary sacrifice arrangement, Alan becomes ill. Because his pay is below the earnings threshold, he’s not entitled to statutory sick pay of £99.35 a week.
Nightmare scenario two – dropping below the National Minimum Wage
Who is affected? The employee and the employer
Another important area where people must be careful is the National Minimum Wage. This is a red line in employment: you cannot pay people anything less than this amount for the hours they do.
Miscalculating pay or hours when applying a salary sacrifice scheme could mean a staff member’s wage will fall below this important legal threshold. If you do underpay your staff in this way, you have to pay the money back… and if you don’t realise it for some time, then this can accumulate to quite a financial hit for your business. This pain is exacerbated when the business finds its contributions to a salary sacrifice arrangement cannot be reimbursed by the pension company.
Things don’t stop there: the government doesn’t hold back in naming businesses, big and small, that break the National Minimum Wage rules.
What can go wrong?
Clara has begun work as a trainee mechanic and is paid National Minimum Wage.
The manager, who’s trying to bring better benefits to employees, recommends that Clara take a new option for a salary sacrifice pension. He thinks that making a head start on a pension early in her career would be a good idea. Clara agrees.
But the problem is that, although this works well for the more senior mechanics, it doesn’t work well for Clara. It takes her pay under the National Minimum Wage. Not only does that harm her ability to get a mortgage with her partner, but it has another knock-on effect.
HMRC has spotted that Clara is one of about 34,000 people in the country being paid less than the National Minimum Wage. The owner is ordered to pay back 12 months of underpaid wages, which he does. However, he finds his contribution to Clara’s pension is non-refundable.
And there’s another surprise in store: the owner’s business gets named and shamed by the UK Government for failing to pay the correct money.
There are other areas affected by salary sacrifice
Salary sacrifice opens the doors to better benefits, and that not only improves the lives of your staff but makes you more competitive when attracting talent.
It’s important, however, to remember that it can affect staff negatively. Other benefits impacted, for example, can include child maintenance and maternity pay (especially the first six weeks). Always research the latest legal updates before trying to implement salary sacrifice, and always keep an eye out in case important legislation changes.
What to do next
Many missteps happen because businesses try and go it alone on payroll; as we have seen, mistakes can mean the price for trying to handle wages can be high for your business or your employees.
At Dataplan, we look after all aspects of payroll, including legislation. This takes the stress away and allows you to focus on what you do best.
Contact us to find out how we can fully manage your payroll.
Dataplan are one of the UK’s leading providers of specialist payroll and associated services.
From payroll outsourcing and pension service management to ePayslips and gender pay gap reporting; we have a solution for you and your business.