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Auto-enrolment and salary sacrifice

Salary sacrifice can be used by employers as a method of fulfilling their auto-enrolment duties. But what exactly are the obligations of auto-enrolment and are there any pitfalls to watch out for when considering salary sacrifice?
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All employers are required by law to provide a workplace pension for certain employees. This requirement is known as automatic enrolment (or the auto-enrolment duty) and it applies to all staff who:

  • are aged between 22 and the State Pension age
  • earn at least £10,000 per annum
  • work in the UK

From April 2019, employers must pay at least 3% of an employee’s qualifying earnings (ie their salary before tax) into this workplace pension. They must also deduct contributions of at least 5% from each eligible employee. If these levels of pension contribution are already made through an existing workplace pension scheme, there is no need to take any action, as the requirements of auto-enrolment will be fulfilled.

Staff members who do not wish to take advantage of auto-enrolment can choose to opt out. They have one calendar month, known as the ‘opt-out period’, to formally leave the scheme and get a full refund of any contributions. In order to opt out, staff must obtain an opt-out notice from the pension scheme, complete this and return it to their employer.

Some key points to bear in mind regarding opting out include:

  • a decision to opt-out must be taken freely and willingly, without any pressure being put on the employee
  • the opt-out period starts from the later of the day the active membership is created or the date an employee receives the letter containing auto-enrolment information
  • employers are required to issue a full refund of any contributions the staff member has made into a pension scheme within a month of receiving a valid notice to opt-out

An employer can make a contractual agreement with an employee to alter the terms of the original employment contract, in order to reduce cash salary payment in exchange for some form of non-cash benefit, such as enhanced pension contributions or childcare vouchers. This type of contractual change, known as salary sacrifice (or salary exchange), can have advantages for both employer and employee, in the form of reduced national insurance contributions.

It is vital that any type of salary sacrifice agreement does not result in cash salary payments falling below the level of the National Minimum Wage.

A salary sacrifice arrangement, where cash payments are reduced in exchange for pensions contributions, can essentially fulfil the auto-enrolment obligation if the required levels of contributions are made by both employer and employee.

However, it is important that employers do not oblige or induce their employees to opt-out of auto-enrolment (eg by implying that salary sacrifice is a pre-condition of auto-enrolment).

A few issues which should be kept in mind when considering a salary sacrifice agreement include:

  • It is important that any changes to earnings related payments (eg pensions and overtime rates) which result from a reduction in cash salary are made clear to the employee.
  • Earnings related benefits such as maternity allowance may be affected by a reduction in cash salary.
  • Salary sacrifice can affect an employee’s entitlement to contribution based benefits such as the state pension and the Employment and Support Allowance.
  • Entitlement to statutory pay (eg sick pay, maternity and paternity pay etc) can potentially be lost if a salary sacrifice agreement reduces an employee’s average weekly earnings below the lower earnings limit.
  • Employers are responsible for ensuring that they pay and deduct the right amount of tax and National Insurance Contributions (NICs) for the cash and benefits they provide.
  • Employers are also required to report any non-cash benefits to HMRC at the end of the tax year. Some non-cash benefits may be exempt from tax and disregarded before calculating NICs, however, any conditions that apply to the exemptions must be satisfied.
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