Auto-enrolment and Salary Sacrifice

Introduction

Employers getting ready for automatic enrolment will want to use an existing pension arrangement to fulfil their statutory duty. But as many established schemes are unlikely to have been set up with auto-enrolment in mind, certain aspects of benefit design may need revisiting to ensure that employers can meet their duties in full.

In this, the first in a series of newsletters looking at tricky auto-enrolment issues for employers, we examine whether salary sacrifice works with auto-enrolment.

Key points

HMRC has confirmed that auto-enrolment can be operated in conjunction with salary sacrifice.
The pension scheme must be a “qualifying scheme”1.
In a DC scheme, the qualifying earnings used to meet the minimum contribution requirements will be based on the post-sacrifice level of salary.2

The auto-enrolment duty

Starting in October 2012, employers will be required to enrol their “eligible jobholders” into a qualifying pension scheme and pay contributions. (An eligible jobholder is a person who works in the UK, who is between the ages of 22 and SPA and who earns more than £8,105.) The duty will apply to the largest employers first, with those employing 120,000 or more persons in their PAYE scheme needing to be on the starting blocks in October 2012.

Unless an employer chooses to postpone auto-enrolment, the new duty will take effect from a jobholder’s “automatic enrolment date” (AED). This is the first date on which a worker meets all the criteria to be an eligible jobholder and the point from which contributions are due and must be calculated.

Salary sacrifice – an introduction3

Salary sacrifice is a contractual arrangement between an employer and an employee, under which the employee “sacrifices” a proportion of their salary in return for non-cash benefits. Where a pension scheme is used for salary sacrifice, the employer will pay an amount equivalent to the sacrificed salary into the scheme on behalf of the member.

Salary sacrifice arrangements are popular, as both the employee and the employer pay lower NICs. However, they are subject to two conditions to ensure that the correct amount of tax and NICs are paid in respect of each element of an employee’s remuneration package:

the employment contract must be effectively varied before the salary sacrifice arrangement is implemented; and
the true construction of the revised employment contract is that the employee is entitled to lower cash remuneration and a higher pension contribution.

Typically, the arrangement to sacrifice will be in place for a period of at least twelve months (subject to a “lifestyle change such as a promotion, marriage, or the birth of a child) otherwise any tax exemption may be lost.

Salary sacrifice and auto-enrolment

The general position

Employers will be able to use salary sacrifice pension arrangements to fulfil their auto-enrolment obligation.

The starting point is that agreeing to a salary sacrifice arrangement cannot be a condition of scheme membership. This is because no provision of a scheme used for auto-enrolment can require a jobholder to express a choice in relation to any matter, or to provide information, in order to become or remain an active member.

Employers will also need to take care that salary sacrifice arrangements are not structured in such a way that could be seen as inducing jobholders to opt-out of auto-enrolment.4

Opting-out: HMRC guidance

Jobholders have a statutory right to opt-out of the pension arrangement into which they are automatically enrolled by their employer and to receive a refund of their contributions.

Because of the need to maintain salary sacrifice arrangements for a minimum period, it is not generally possible for an employee to revert to their higher, pre-sacrifice salary before the end of the set period. This would have made it difficult to operate the statutory opt-out procedure for jobholders enrolled automatically into pensions saving alongside a salary sacrifice arrangement.

HMRC has therefore updated its “Salary Sacrifice Q&A” in line with the auto-enrolment requirements to confirm that any reversion to a higher salary will be possible for jobholders who opt-out of a salary sacrifice pension arrangement and that no minimum period will apply.

New salary sacrifice arrangements

Salary sacrifice can be used for individuals not already in pensions saving (either new hires or jobholders with no current pension scheme membership), provided certain conditions are met.

As the core employer duty is to ensure that jobholders are in active membership of a qualifying scheme with effect from the AED, any new salary sacrifice arrangement would need to be put in place before this date. In practice, this may not always be achievable given the tight timescales for auto-enrolment. In these circumstances, an employer could buy itself more time by choosing to postpone auto-enrolment5 – imposing a waiting period could give the employer time to put new salary sacrifice arrangements in place.

However, an employer will need to have alternative arrangements in place to cover any jobholders who fail to respond to their offer to enter into a salary sacrifice arrangement, so that they can be enrolled in line with the standard auto-enrolment provisions.

Existing salary sacrifice arrangements

For existing members of qualifying schemes, the interaction of any salary sacrifice arrangement with the auto-enrolment requirements will depend on what has been contractually agreed between the member and his/her employer.

In many cases, ongoing salary sacrifice arrangements which renew automatically will be unaffected by auto-enrolment. However, employers will need to ensure that they do not do anything which would cause a jobholder to lose active membership of a qualifying scheme, or which could be seen as an inducement.

As for new salary sacrifice arrangements, if an employer requires members to actively renew the salary sacrifice arrangement (which it may do for administrative reasons), it will need to ensure that it has a default auto-enrolment vehicle in place for any jobholders who choose not to (or who fail to) renew their salary sacrifice. Arrangements would also need to be made to enable contributions to be paid out of the individual’s higher, pre-sacrificed salary going forwards.

As a salary sacrifice arrangement involves the variation of an employee’s employment contract, any change in the arrangement would need to be achieved by way of a legally enforceable variation in the employee’s terms and conditions.

Coming soon!

Our next Alert on tricky auto-enrolment issues will focus on the operation of flexible benefits with auto-enrolment. Sackerstv will also include a general feature on tricky issues in this area.

1 An occupational or personal pension scheme, usually registered under the Finance Act 2004, which satisfies the quality requirements (which vary depending whether a scheme is DB, DC or hybrid). For more information, please see our Newsletter: “On your marks: Will your scheme qualify for auto-enrolment?” (dated 26 March 2012)
2 The minimum contribution levels for DC schemes will be phased in between October 2012 and October 2018. Current information on the phasing dates that apply are set out on TPR’s website
3 For more information, please see our insight on salary sacrifice
4 An offence under the Pensions Act 2008
5 For a period of their choice of up to three months