Although salary sacrifice is not a new idea, it has grown in popularity in recent years as more employers take advantage of the tax and national insurance savings they can generate. Our research indicates that the vast majority of UK companies with employee benefits in place have implemented a salary sacrifice scheme.
Due to the complex administration and communication headaches, many employers may struggle to administer their salary sacrifice scheme and ensure that they are getting return on investment. Yes as with all other parts of your benefits programme, salary sacrifice is about designing the right policy, issuing the right communications to engage employees and implementing the right processes to make it all work.
So what is salary sacrifice?
Salary sacrifice is a way of paying for employee benefits. It happens when the employee makes a contractual agreement with their employer to give up part of their cash remuneration (usually basic salary) in return for the company agreeing to provide a non-cash benefit.
It is the standard way of providing employees with access to schemes such as the cycle-to-work scheme, which is tax-exempt under a specific Government initiative. Salary sacrifice is also a very common way of managing pension contributions and other tax-efficient benefits, including health assessments, additional annual leave and some insurances.
Salary Sacrifice is also the typical mechanism for managing flexible benefits, including those that would be taxable as a benefit-in-kind, such as private medical insurance. Although this doesn’t generate any savings for the employer, it may still effectively save employees National Insurance Contributions (NIC) compared to a net-pay deduction.
As it is a change to terms and conditions of employment and has significant tax advantages, there are many requirements to make sure that it is compliant and would meet with HMRC ‘approval’. These include:
• Timing of the agreement – the agreement cannot be backdated in any way and must be for a reasonable period of time, generally accepted as one year;
• Evidence of the change – HMRC has set out guidelines for the ways in which the variation to T&Cs can be evidenced. The devil is in the detail however, and legal opinion is always prudent;
• Enrolment opportunities – although some benefits are completely exempt meaning there is no need for a life event, other benefits need to be tightly controlled;
• A policy for employees on leave of absence – for many years there was a grey area surrounding how to treat employees on maternity (and now paternity) leave. More recently, however, a common approach has been advised by HMRC (representing itself and other Government departments), stating that the employer must fund the benefits during the period of absence or face the risk of discriminating against those people. Planning and funding for this are essential.
Other than ensuring the policies and processes are correct, salary sacrifice, like any other element of your reward and benefits package, needs to be well communicated and administered to generate employee engagement and maximise the savings available.
Why introduce it?
Unlike flexible benefits, where employers tend to invest money to see a return on investment over the medium to long-term, most companies justify implementing salary sacrifice on the basis of the short-term direct cost savings, in the form of reduced National Insurance (NI) payments.
Take the example of an employee, earning £40,000 per annum, paying 5% into their pension. If this was done via salary sacrifice, the employer would save 13.8% of what was sacrificed, which is £276 p.a. (based on 2012/13 tax rates and assuming the scheme is contracted-in). Multiply this out for 300 employees, and the saving becomes approximately £83k each and every year the scheme runs.
Even when taking into consideration the cost of implementing, communicating and administering the scheme, the size of potential savings explains why take-up of the initiative is so high. For example, DAC Beachcroft offset the cost of their flexible benefits programme by implementing salary sacrifice, which saved them an annual £120,000 in National Insurance savings.
As the savings are so significant, some employers pass at least a share of the NI savings to employees, while 37% of employers retain the full saving.*
We don’t believe companies that retain the saving lose out significantly in other ways, such as creating dissenters or detractors in the employee population, but there are more companies that tend to share their savings with employees, either in the form of a pension top-up, or to help fund other benefits and initiatives, such as flexible benefits.
Overall, salary sacrifice is a great way to expand the range of benefits on offer and add value to your package at little to no cost. This can be done whilst still supporting key aspects of your employee’s work-life balance, such as childcare, green travel and retirement.
How to implement salary sacrifice?
1) Business case and approach
First, we recommend you agree your approach with key stakeholders, so that you can be clear on the potential costs and savings and how you want to use them. Keeping sight of those objectives and their reasons when it comes to communication of the scheme is vital.
2) Policy and process design
Next, you’ll need to set out scheme rules, both for internal use and for your employees. They will also come in handy should you want to approach HMRC for ‘approval’ of the scheme once launched. You will need to consider how the savings are processed, when employees can enrol, what life events are valid, how you will record the change to terms and conditions and how you will handle exceptions, such as when the use of salary sacrifice will mean an employee falls below the National Minimum Wage.
Salary sacrifice doesn’t sound like the most appealing initiative and so communication is key to maximising participation and engagement with the scheme. If it is part of a longer term plan to introduce flexible benefits, then it is worth considering launching the scheme under a brand with which employees identify.
In addition to this, you need to promote the scheme to employees while ensuring everything is technically correct and compliant. A wrong word here or there can make a huge difference!
If done in isolation, salary sacrifice can be a relatively easy initiative to implement. Where you are looking to manage several schemes in this way, such as pensions, childcare and bikes, the case for technology becomes even more compelling, as it will provide the audit trail needed to support compliance.
* Employee Rewards Watch 2013