There are 3 different methods of processing pension scheme deductions:
This article lays out the differences in each type and the things that employers should consider when choosing who to operate their pension scheme.
Salary Sacrifice
What is salary sacrifice?
Salary sacrifice is the method of reducing gross pay by the amount of the pension contribution which in turn reduces the pay on which you calculate:
Tax
Employee and Employer National Insurance
Salary sacrifice is a tax-efficient and cost-effective way of deducting both employee and employer pension contributions.
Considerations for a salary sacrifice scheme
When setting up a salary sacrifice scheme it is important to remember that
Employees must agree to enter in to a salary sacrifice arrangement, as they effectively reduce their gross pay
Salary sacrifice reduces gross pay which means that an employee’s eligibility for things such as statutory sick and statutory maternity pay may be impacted
National minimum wage is calculated on post-sacrifice earnings. It is not permissible to reduce an employee to below the minimum wage because of their salary sacrifice deductions.
Relief at Source
What is relief at source?
Relief at source is the process whereby pension deductions are taken from net pay after the deduction of tax.
80% of the employee's pension deduction will be taken via the employee's pay, and the remaining 20% will be automatically reclaimed by the pension provider which is then added in to an employee’s pension pot.
The 20% tax relief will still be given if the employee has not paid tax in the tax year due to their earnings falling below the annual threshold (£12,500 for 2019/20).
Considerations for operating relief at source
The month to month cost is higher for an employee and employer as deductions are taken after the calculation of tax and National Insurance
The annual saving is still lower than a salary sacrifice arrangement as there is no National Insurance relief
Relief is paid straight in to an employee’s pension pot, unlike salary sacrifice arrangements
Employee’s in higher tax brackets need to reclaim any additional tax relief via self-assessment
Net Pay Arrangement
What is a net pay arrangement?
Processing pension deductions through a net pay arrangement is where deductions of pension are taken before the tax calculation, lowering gross taxable pay.
This arrangement does not provide a National Insurance saving for the employee or employer.
Considerations for net pay arrangement
Relief is given at the rate of tax the employee pays
As a result no relief is available if an employee does not pay tax
The below table shows the impact net impact to the employee and employer of each arrangement
