AUTOMATIC ENROLMENT: SALARY SACRIFICE AND FLEXIBLE BENEFITS

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1 PENSIONS PROFILE JULY 2012 AUTOMATIC ENROLMENT: SALARY SACRIFICE AND FLEXIBLE BENEFITS Summary Salary Sacrifice is a mechanism allowing an employee to give up the right to part of his or her remuneration in return for a benefit, e.g. extra pension contributions. This has the advantage of saving national insurance (NI) for both the employee and employer this saving would be an obvious way of helping to mitigate some of the costs associated with auto-enrolment. A flexible benefits scheme allows employees to choose between benefits, e.g. childcare or pensions. Salary sacrifice/flexible benefits schemes will be able to coexist with the new auto-enrolment requirements commencing from October Employers that offer pensions through salary sacrifice, or as part of a flexible benefits plan, will need to review their current operation to ensure they meet the new auto-enrolment duties. Non-mandatory salary sacrifice arrangements are acceptable in principle, provided that eligible jobholders can become active members of the pension scheme without having to consent to salary sacrifice to achieve that result (which would breach the auto-enrolment requirements). For eligible jobholders who do not want to use a salary sacrifice arrangement, the employer will have to make available an alternative payment method. If the employer is using a DC scheme then the "qualifying earnings" used to meet the minimum requirement are the post-sacrifice level of salary (in reality most employers do actually base their contributions on the pre-sacrificed salary (for employer/employee relations). Employers must be sure their flex package does not induce employees to opt out of a workplace pension scheme once they have been auto-enrolled. = ANY QUESTIONS? If you have any questions or comments in relation to this article, please pensions.technical@landg.com

2 2 PENSIONS PROFILE Introduction This profile examines how salary sacrifice and flexible benefit schemes will interact with an employer s requirements to meet minimum duties under automatic enrolment. Using salary sacrifice as the contribution method for auto-enrolling eligible employees HMRC has confirmed that the salary sacrifice method is feasible. Salary sacrifice is an arrangement where the employee forgoes salary in return for a "non-cash benefit" in this case a pension contribution. A more detailed explanation of how salary sacrifice works is contained in the Pensions Profile Salary Sacrifice. Salary sacrifice is not in itself a legal term and there are no specific statutory provisions. Instead, an employer and employee make what is known as a salary sacrifice arrangement by agreeing the terms of the employee s contract of employment. The employee agrees to a reduced gross salary, but also receives an additional non-cash benefit from the employer such as childcare vouchers, travel and subsistence expenses or pension contributions. The legal basis is in employment and contract law. Given the potential NI savings for both employees and employers, salary sacrifice can be very advantageous. The auto-enrolment process has to operate automatically, without requiring employees to make any decisions. Therefore it will not be possible to ask employees to decide whether or not they want salary sacrifice when they are auto-enrolled. However, this can be done afterwards. Furthermore, if an employee joins the pension scheme voluntarily (ie without being auto-enrolled) they can be asked when they join to choose whether they want salary sacrifice. An employee might join voluntarily during the scheme's postponement period, for instance. The auto-enrolment legislation contains no direct references to salary sacrifice; it just states that restrictions to joining cannot be put in place. Therefore, making salary sacrifice the sole mechanism to achieve auto-enrolment will be deemed a restriction. In other words, if an employee decides they did not want to put a salary sacrifice arrangement in place, the employer would have to find an alternative payment method to fulfil their automatic enrolment duties in respect of that employee. 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. Example: Emma earns 10,000 a year and is aged 25. Auto enrolment is on the horizon and Emma s employer identifies that money can be saved by using salary sacrifice there is a NI saving. Emma is informed that the employer is setting up a pension scheme and is offered membership on a salary sacrifice basis (it saves her NI too). Emma regards this as a good idea and agrees to amend her contract of employment. This is voluntary; Emma has not been auto-enrolled. She has joined because that's the agreement in her employment contract. If she chooses not to join on the salary sacrifice basis her employer will then need to look at all the eligible jobholders at their staging date. Emma now fulfils the criteria of being an eligible jobholder because her salary is above the trigger figure of 8,105. Therefore she must be auto enrolled into an appropriate auto-enrolment scheme (potentially the same scheme she could have joined on a salary sacrifice basis).

3 3 PENSIONS PROFILE Salary sacrifice basis of the pension contribution Minimum contributions are required to be paid on a qualifying earnings band currently between 5,564 and 42,475. In a salary sacrifice case contributions would be payable on the post sacrifice salary within that qualifying earnings band. Whilst the minimum contribution need only be based on the post-sacrificed salary, most employers will probably base contributions on the pre-sacrificed salary; it may not assist employer/employee relations if the post-sacrificed salary is used. Example: Alan earns 20,000 and is not currently a member of a pension scheme. He is contacted by his employer about a salary sacrifice arrangement. Alan s contribution is 5% and his employer s contribution is 3%. Alan decides to opt for salary sacrifice and his salary is reduced by 1000 to 19,000. The 8% minimum contributions are payable by the employer on the employees earnings between 5,564 and 19,000. This would be around 1,074. If an employer is looking to save money, the salary sacrifice route can be appealing. Not only will the employer save NI but, as we can see, any contribution made by the employer to the pension scheme need only be based on the post-sacrificed salary. In Alan s example above, reducing the salary to 19,000 saves him 12% NI on the 1,000 sacrificed - a saving of 120. His employer also saves NI 13.8% on 1,000 - a saving of 138. In addition, reducing salary to 19,000 means that the employer need only contribute 3% of the qualifying band ( ) as opposed to 3% of 20,000-5,564 ( ). In total a saving to the employer of 168 ( ). Opting out Following lobbying by scheme providers, HM Revenue & Customs (HMRC) has amended its salary sacrifice guidance ( to prevent the unfair treatment of workers opting out of auto-enrolment. This is because it is only normally possible to amend a salary sacrifice arrangement after a set period although HMRC do consider certain "lifestyle changes" can end the arrangement earlier than expected e.g. birth of a child/illness/divorce (and auto-enrolment would have been an anomaly as this had not been deemed such an event). What could have happened if auto-enrolment had not been deemed to be a life-changing event is that the employee's salary would not have reverted back to the pre-sacrificed amount and the refund would be paid to the employer for the employer to keep. In addition, for employers, this meant that as there was a danger by allowing employees to cancel a salary sacrifice arrangement, the validity of the entirety of the company's sacrifice arrangement could have been called into question from both a tax and NI perspective. Fortunately, this new guidance means it is not necessary to stipulate a period for which the arrangement must be entered into or to set out "lifestyle changes" in relation to salary sacrifice for the workplace pension scheme. So employees will be able to opt out of the pension scheme at any time, returned to their pre-sacrifice salary level and be entitled to a full post tax and NI salary refund, returned through payroll. Timing An employer may ask the employee if they want to put in place a salary sacrifice arrangement but they must do so ahead of the employee s automatic enrolment date, so that they can become a member of the qualifying scheme from that date. Employers may decide to use postponement in respect of the employee to give them time to make these arrangements. However, if the employee declines to set up a salary sacrifice arrangement, or they do not respond to the employer s offer, the employer must automatically enrol in line with the automatic enrolment provisions.

4 4 PENSIONS PROFILE Qualifying schemes The pension scheme the employer uses for enrolling under a contractual agreement (for example under a contract of employment) using salary sacrifice must be qualifying. If it is not, the employer duties will still apply and, if the worker meets the eligible jobholder category, the employer will still have an automatic enrolment duty for them. Flexible benefit schemes Many employers offer a flexible benefit arrangement under which workers select, based upon lifestyle choices, which benefits they wish to receive in a given year. Such arrangements will need to be reviewed to ensure they will be compliant with automatic enrolment requirements. The Pensions Regulator views flex packages as less clear cut than salary sacrifice, the problem being that the offer of alternative benefits could be viewed as an inducement to opt out of pension saving. However, the Regulator has said that its intention is not to restrict flex packages individuals have the right to choose the make-up of their flexible benefits. The majority of flexible benefit schemes seem to work on the basis that there is a basic salary, then sitting on top of this an amount that can be flexed to provide other benefits. An eligible jobholder would need to be auto-enrolled. Their contribution will be on their pay after the flex benefits have been set. Example: John has a basic pay of 30,000 and 5,000 available for flex benefits. John will have to be auto-enrolled. If he uses all of the 5,000, his pension contributions will be based on 30,000. However, John uses just 3,000 with the 2,000 balance added to his pay; his pension contributions must now be based on 32,000. It is important to remember the following: With auto-enrolment there must be no requirement for the jobholder to make a choice about whether to have a pension; they must first be auto-enrolled into a pension scheme at or above the relevant minimum contribution level required to make the scheme qualifying. Enrolment must be able to take place at the minimum contribution level (of 8% in total) even if the employee has not made any specific election regarding their flexible benefits options. Having been enrolled with effect from the automatic enrolment date, the employee is free to reduce or increase the level of contributions in accordance with the rules of the flexible benefits arrangement and of the scheme. Depending on how the arrangements are structured, there may be an argument that the non-pension benefits could breach the automatic enrolment requirements by constituting an inducement to opt-out of pensions. The Regulator has stressed that employees must not be allowed to flex down below the statutory minimum in exchange for another benefit, and provides an example in page 10 of Guidance no. 8 Safeguarding individuals :

5 5 PENSIONS PROFILE The employer offers their staff a flexible benefits package where membership of a pension scheme is one of a range of benefits on offer. The employer automatically enrols all their eligible jobholders into the pension scheme. After being automatically enrolled, some individuals choose to opt out in favour of a non-pensionable benefit or cash alternative. Some may decide that they still want to make pension contributions but at a lower rate (i.e. into a non-qualifying scheme or non-qualifying section of the same scheme). The intention of the legislation is to encourage pension saving at a minimum level, not to restrict flexible benefits packages that employers wish to offer their workers. The individual retains the right to choose the makeup of their flexible benefits. However, employers must be confident that, in offering such a package, their sole or main purpose is not to induce individuals to opt out of a qualifying scheme. Although the jobholder may choose not to complete an opt-out notice if they move to a non-qualifying scheme or section of an otherwise qualifying scheme, they are still giving up membership of a qualifying scheme. The employer must therefore still be confident that they can demonstrate that, in offering membership of non-qualifying schemes or sections of an otherwise qualifying scheme as part of the overall package, their sole or main purpose is not to induce individuals to leave the qualifying scheme or section.

6 This is not a consumer advertisement. It is intended for professional financial advisers and should not be relied upon by private customers or any other persons. This document is based on Legal & General s current understanding of tax law, HMRC practice and legislation which may change. It should not be considered a definitive statement in law. Legal & General Assurance Society Limited Registered in England No Registered office: One Coleman Street, London EC2R 5AA Authorised and regulated by the Financial Services Authority. PP07/12 Non GASD