Employment and pensions

HR pensions spotlight | Salary sacrifice and pensions

Published on 24th Mar 2021

We take a look at some of the potential pitfalls of using salary sacrifice arrangements for pension contributions.

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In recent months, we have been advising clients on some thorny issues that can arise when using salary sacrifice arrangements for pension contributions to defined contribution schemes.

Pitfall 1: Forgetting to make a contractual change

Salary sacrifice involves a change to an employee's contract of employment. Specifically, the employee agrees to give up part of their cash salary in return for an equivalent amount of  employer pension contributions.  This change needs to be documented by amending the employment contract, or by a side letter/addendum.

Pitfall 2: Not giving employees enough information to give informed consent

A change to the employment contract can only be made with the employee’s consent. The best evidence of consent is express written consent, by "opt-in" to the salary sacrifice.  Deemed consent, as a result of not opting out, however is also a commonly used approach.  In this case, the employee technically accepts the change later, when the impact of the sacrifice is first felt, but provided the explanation of the change makes clear the practical effects of the sacrifice, and the sacrifice affects pay which is not yet earned for tax purposes, the salary sacrifice should be effective.

Pitfall 3: Working out the impact on maternity pay

How much to pay? An employee’s earnings and national insurance contributions (NICs) will be lower as a result of the reduced salary. Earnings-related state benefits, such as maternity allowance and statutory maternity pay (SMP), will be calculated using the reduced salary figure. If the employee is entitled to contractual maternity pay, the employer may decide to use a notional salary figure (that is,  the unreduced salary) or the reduced salary figure in its calculations.

How long to pay? Generally speaking, employee benefits must continue to be provided throughout ordinary maternity leave (OML: weeks 1 to 26 of maternity leave) and additional maternity leave (AML: weeks 27 to 52 of maternity leave), so for the full 52 week period of leave.  This is the case even where the woman is no longer entitled to receive pay (and SMP is payable for 39 weeks maximum).

However, for pension salary sacrifice arrangements, the employer contribution is not generally regarded as a benefit to be continued during unpaid AML.  Social security legislation requires employers to pay pension contributions during OML and any paid period of AML at the same rate as before maternity leave, so based on the employee’s pre-maternity leave salary.  Where employees make contributions, they only need to be based on the pay they are receiving at the time.  In the case of salary sacrifice, however, all contributions are employer contributions so strictly speaking they should continue based on pre-maternity leave salary for any period of paid AML.  Arrangement terms that automatically end the sacrifice or reduce the amount exchanged when an employee's circumstances change therefore need careful review.

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* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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