Sample Letters to Employees to Reduce Salary

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					Salary sacrifice
from Scottish Life




                     Technical guide

                       for financial advisers
        Technical guide for financial advisers




Paying contributions to a pension scheme is a tax efficient way of
saving for retirement. The employee receives tax relief on their own   Acronym heaven
contributions and employer’s contributions are treated as a business   HMRC - Her Majesty’s Revenue and Customs
expense for Corporation Tax purposes. To provide extra value for       NIC – National Insurance Contribution
employees, the employer could set up a salary sacrifice arrangement    LEL - Lower Earnings Limit. This is the minimum level of earnings that an
to further increase savings towards retirement.                        employee needs to qualify for some state beneifts
                                                                       OPS – Occupational Pension Scheme
This Technical Guide covers a number of important points               PP – Personal Pension
concerning salary sacrifice such as the advantages and
disadvantages for both the employer and employee. We’ve also
included:

– an example of salary sacrifice in practice

– sample agreement letters

– a handy decision tree

– a sample payslip

– a payroll process flow




2
What is salary sacrifice?                                                  Setting up the arrangement
Salary sacrifice is an arrangement where an employee gives up              Although a salary sacrifice arrangement can be set up at any point
the right to a specific amount of their future salary or bonus in          during a year, any agreement must be in place before the salary
exchange for a non-cash benefit, typically an employer pension             is actually sacrificed. This must be done so that HMRC deem the
contribution. As salary is being sacrificed rather than paid, there’s      sacrifice ‘effective’. HMRC also state in their guidance that in order
no Income Tax or NICs to pay on the sacrificed amount resulting            to be successful, any salary sacrifice must:
in lower tax and NICs for the employee and lower NICs for the
employer.                                                                  – be in writing, signed and dated

There are a number of options on what the employer and employee            – not be retrospective
can do with the savings generated. The most common method is
to structure the arrangement so the employer’s overall salary bill         – constitute an enforceable variation of the employee’s right to
remains unchanged with the employee taking home the same net                 remuneration
pay. If the employer is willing to reinvest all of their NIC saving, the
employee will also benefit from increased pension contributions. A
win-win situation for everyone.                                              Salary sacrifice is a matter of employment law, not tax
                                                                             law. When a salary sacrifice arrangement is set up the
How does it work?                                                            employee agrees to sacrifice an entitlement to future
With salary sacrifice, the employee decides how much salary they             salary or bonus.
want to sacrifice and their salary is reduced by this amount. The
amount sacrificed is paid into their pension arrangement as an               We would strongly recommend that the employer’s legal
employer contribution.                                                       advisers review any changes to employees’ contracts of
                                                                             employment.




                                                                                                                                                    3
Bonuses                                                                     The agreement letter
It’s possible to sacrifice a bonus (or part of it) and have it treated as   To set up salary sacrifice, the employees’ contract of employment
an employer pension contribution. Bonuses can either be paid on a           must be changed and this is done by the signing of a written
discretionary basis or contractually, as part of an employee’s contract     agreement (see appendices 1 and 2 for sample letters for sacrificing
of employment. They are treated differently for salary sacrifice            salary and contractual bonus).
purposes.
                                                                            Importantly, the agreement must be made before the employee
If the employer pays a bonus on a discretionary basis there’s no            is paid the salary or bonus so the alteration to the employee’s
expectation by the employee of receiving it. Since there’s no prior         contract of employment must be in place well in advance of the first
expectation, there’s no alteration to the contract of employment so         contribution being made. It’s also worth noting that the employee
no written agreement is needed. The employer can pay an amount              cannot retain the right to revert back to the higher salary. Doing so
of bonus in part or full to the employee’s pension arrangement,             would deem the salary sacrifice ineffective.
with no paperwork required.
                                                                            An ineffective salary sacrifice would mean that income tax and NIC
If a bonus is contractual, the rules for the sacrifice are the same         would be calculated on the original salary.
as those that apply when sacrificing a proportion of salary – it’s
a change of the employee’s contract of employment. It must be               Constructing the arrangement
made in writing and implemented prior to the bonus payment.                 The employer can set up the arrangement in a number of ways. In
                                                                            this guide, we look at 4 options:
Where can salary sacrifice be used?
Salary sacrifice can be introduced on an individual basis for each          1. Employer costs reduce, employee’s take home pay increases,
employee. But it can be more cost effective for the employer to                no change to pension contribution
offer it to all employees.
                                                                            2. Employer costs reduce, no change to employee’s take home pay,
To consider using salary sacrifice there must be a pension scheme              increase in pension contribution
in place capable of accepting employer contributions. For example,
salary sacrifice can’t be used with a ‘section 32’ policy. Salary           3. No change to employer cost, employee’s take home pay
sacrifice can be used with:                                                    increases, increase in pension contribution

– an occupational contracted-in money purchase scheme                       4. No change to employer costs, no change to employee’s take
                                                                               home pay, increased pension contributions.
– a personal pension (and group personal pension)

– a stakeholder pension (and group stakeholder pension)

– an executive pension plan.

Contracting-out and the difficulties associated with NIC rebates
means using salary sacrifice in conjunction with contracting-out
creates administration complexity and additional cost so it’s unusual
for salary sacrifice to be used with contracting-out arrangements.




4
Salary sacrifice examples
There are various tax and NIC savings that can be made with a salary sacrifice arrangement. It’s how these savings are used that can really
make a difference and this depends on how the arrangement is set up. There is no hard and fast rule as to what an employer should do with
any tax or NIC saving resulting from a salary sacrifice arrangement. Reinvesting these savings into the pension scheme for the employees will
of course give them the most benefit from the salary sacrifice arrangement and may encourage scheme take-up.

What can be done? There are 4 basic options. So let’s look at some examples. These assume an employer provides an employee earning
£20,000 with a PP arrangement where both employer and employee are currently paying a pension contribution of 5% of gross salary.

Option 1 – Employer costs reduce, employee’s take home pay increases, no increase in pension contribution

                                                            Before sacrifice                                 After Sacrifice

 Employer position
 Total cost (includes pension contribution
 and NICs payable)                                            £22,864.32                                       £22,736.32
 Difference to cost                                                                      -£128.00

 Employee position
 Take home pay                                                £14,804.85                                       £14,914.85
 Difference to take home pay                                                            +£110.00

 Gross pension contributions                                   £2,000.00                                       £2,000.00
 Difference in pension contributions                                                      £0.00

With this option, the employee sacrificies 5% of gross salary, none of the NIC and/or tax savings are reinvested in the pension scheme, and
the employee pays less tax and NICs on a reduced salary, which increases their net take home pay.

Option 2 – Employer costs reduce, employee’s take home pay remains the same, increase in pension contribution.
                                                            Before sacrifice                                 After Sacrifice

 Employer position
 Total cost (includes pension contribution
 and NICs payable)                                            £22,864.32                                       £22,715.91
 Difference to cost                                                                      -£148.41

 Employee position
 Take home pay                                                £14,804.85                                       £14,804.85
 Difference to take home pay                                                              £0.00

 Gross pension contributions                                   £2,000.00                                       £2,159.42
 Difference in pension contributions                                                    +£159.42

With this option, the employee sacrifices a slightly higher amount than 5% to produce exactly the same take home pay. And because
they’ve sacrificed slightly more, their pension contribution increases. None of the employer NIC savings are reinvested.
                                                                                                                                              5
Option 3 – Employer costs remain the same, employee’s take home pay increases, increase in pension contribution.

                                                            Before sacrifice                                  After Sacrifice

    Employer position
    Total cost (includes pension contribution
    and NICs payable)                                          £22,864.32                                       £22,864.32
    Difference to cost                                                                       £0

    Employee position
    Take home pay                                              £14,804.85                                       £14,914.85
    Difference to take home pay                                                          +£110.00

    Gross pension contributions                                £2,000.00                                         £2,128.00
    Difference in pension contributions                                                  +£128.00

With this option, only the employer’s NIC saving is reinvested, resulting in the higher pension contribution. As the employee has only
sacrificed 5% of gross salary, their take home pay increases.

Option 4 – Employer costs remain the same, employee’s take home pay remains the same, increase in pension contribution.
                                                            Before sacrifice                                  After Sacrifice

    Employer position
    Total cost (includes pension contribution
    and NICs payable)                                          £22,864.32                                       £22,864.32
    Difference to cost                                                                     £0.00

    Employee position
    Take home pay                                              £14,804.85                                       £14,804.85
    Difference to take home pay                                                            £0.00

    Gross pension contributions                                £2,000.00                                         £2,307.83
    Difference in pension contributions                                                  +£307.83

With this option, the position remains cost neutral for both employee and employer. The employee gives up slightly more than 5% of gross
salary so that take home pay remains the same. All the savings are reinvested into the pension.

All figures are based on annual tax allowances and NIC thresholds/limits and are for illustration purposes only. Based on rates of income tax
and NI for the 2008/2009 tax year and a single person’s tax allowance of £6,035. These may be affected by future changes in tax, national
insurance contributions, legislation or by an individual’s particular circumstances.




6
Which option?                                                            The advantages
It’s down to the employer as to which option is chosen but we’d
                                                                         Employers pays less NICs
recommend Option 4 as:
                                                                         As employees will be getting a lower salary, the amount of NICs the
•	 	t’s completely cost neutral at the bottom line for employers and
   i                                                                     employer pays will also reduce. The NIC savings are linked to the
   employees                                                             level of employees’ pension contributions so a quick way to estimate
•	 it maximises pension contributions.                                   the NIC saving is to add up the total of employee contributions and
                                                                         apply the NIC payment rate of 12.8%. For example:
You should remember that personal circumstances vary and your
recommendation should be made following an assessment of your             Average employee salary                                            £20,000
client’s needs and circumstances.                                         Average employee contribution rate                                   x5%
                                                                          Annual employee contribution                                       =£1,000
Reporting requirements                                                    Active members                                                        x50
HMRC don’t have to be notified of a salary sacrifice arrangement
                                                                          Employer NIC rate                                                  x12.8%
and they will not comment on the effectiveness of any arrangement
                                                                          Annual employer NIC saving                                         =£6,400
before it is in place. But employers can ask their local tax office to
confirm if they are applying correct tax treatment after it has been     These figures are for illustration only and are based on rates of income
set up. This can give employers peace of mind that the arrangement       tax and NI for 2008/2009 tax year.
has been constructed correctly.
                                                                         Corporation Tax Relief
To determine the effectiveness of the salary sacrifice arrangement,      Next, because the amounts sacrificed are paid as an employer
the local tax office will need to see:                                   pension contribution, corporation tax can be claimed back in the
                                                                         normal way.
– evidence of the variation of the employee’s contract of
  employment (usually the salary sacrifice agreement letter)             Increased pensions for employees
                                                                         For employees, a reduction in their salary may look bad but it does
– payslips before and after the change of employment terms               also mean a reduction in tax and NICs which offsets the top line drop.
                                                                         And the salary sacrifice arrangement can be structured so that these
– information about the benefit in kind being provided                   savings can be reinvested into the pension arrangement, meaning the
                                                                         employee’s take home pay stays the same and they’ll benefit from
                                                                         higher pension contributions as shown in the examples earlier.

                                                                         Adding true value to the benefits package
                                                                         Finally, introducing salary sacrifice can help boost the employer’s
                                                                         image as one who values their employees and the benefits package
                                                                         that’s provided for them. This can be an even more powerful message
                                                                         when the employer agrees to reinvest their NIC savings to further
                                                                         increase pensions savings. More importantly, once the employer gets
                                                                         that message over to their employees, it can only help in encouraging
                                                                         them to join the scheme. And a valuable benefits package can also
                                                                         help with the recruitment and retention of quality staff, potentially
                                                                         giving employers an edge over their competitors.




                                                                                                                                                       7
What are the disadvantages of salary sacrifice?                            Costs
From the employee’s perspective, the main disadvantage is that             The costs associated with salary sacrifice are mainly related to the
their gross salary is being reduced by the amount of the sacrifice.        extra administration and the employer’s communication program.
However there are other considerations which need to be taken in
account such as:                                                           The employer could consider offsetting the costs incurred by using
                                                                           the first year’s NIC savings then in the second year, savings can be
   E
•	 	 mployees	will	need	to	understand	the	effect	on	‘other’	benefits	
   that are linked to their (reduced) salary. However, even although       redirected to the employees’ pension arrangements.
   gross salary has reduced, the employer can alter the definition
   of salary (in rules or conditions) so that, for example, benefits on    Alternatively, costs such as required alterations to admin/payroll
   death, overtime rates and redundancy payments are linked to the         systems could be spread over a number of years being partly met
   pre-sacrificed amount. This is commonly known as ‘notional basic        by the employer and partly from the NIC savings achieved from
   salary’.                                                                salary sacrifice. The employees would immediately benefit from the
                                                                           employer reinvesting the remaining NIC savings.
   I
•	 	f	an	employee	is	thinking	of	applying	for	a	mortgage	they	should	
   bear in mind that some mortgage lenders will base the amount            It’s also worth highlighting that there may be extra employer costs
   that they are willing to lend on the employee’s salary after            associated with absences. For example, where an employee is on
   salary sacrifice. So the reduction in salary may in turn reduce the     maternity leave or long-term sick and not receiving occupational
   amount they can borrow.
                                                                           maternity or sick pay, the employer must continue to provide all
                                                                           benefits that are required under the employee’s normal remuneration
   T
•	 	 here	are	statutory	benefits	linked	to	the	lower	salary	that	the	
   employer has no influence over and we’ve highlighted some areas         package. In these instances, the employer must continue to pay
   that would need to be considered :                                      pension contributions even though the cost cannot be recovered
                                                                           through the salary sacrifice arrangement. This is because, at the
    -   Basic state pension     - Statutory maternity, paternity           outset, the change in the contract of employment transfers the
    -   State second pension      and adoption pay                         responsibility for pension contributions to the employer.
    -   Incapacity benefit      - Statutory sick pay
    -   Jobseeker’s allowance   - Working or child tax credit              Clearly, communication is vital in not only explaining the employer’s
                                                                           intentions through implementing salary sacrifice but also on how
    For example, one of the qualifying conditions for statutory            the NIC savings will be used.
    maternity, paternity and adoption pay is that the employee’s
    earnings on average are at or above the LEL during a specified         Communication
    period of eight weeks. If the average weekly earnings are below
                                                                           The success of salary sacrifice will be measured by how many
    the LEL then the employee will not qualify for payment of these
    benefits by the employer.                                              employees commit to the arrangement. There’s no point in an
                                                                           employer taking the time to set up an arrangement and bearing
•	 	 nder	an	OPS,	employee	contributions	can	be	returned	in	the	
   U                                                                       the costs if take up is low. So clear communication is key if a salary
   event of death whilst in pensionable service. As sacrificed salary is   sacrifice arrangement is to be successful.
   deemed to be an employer contribution, these won’t be returned
   on death. This would also apply if an employee left the scheme          For employers who choose option 4 above, we’ve produced a
   with less than 2 year’s pensionable service.                            simple and straightforward employee guide that the employer can
                                                                           send to employees as part of a clear communication strategy. It
   A
•	 	 n	employee	cannot	sacrifice	an	amount	of	salary	that	would	           highlights the issues employees need to consider before committing
   result in their post sacrificed salary falling below the level of the   to salary sacrifice such as how salary sacrifice affects take home pay
   National Minimum Wage.                                                  and pension contributions.

                                                                           The employee guide can be used as part of a wider company
                                                                           communication strategy. For example, if the employer is
                                                                           undertaking an exercise targeting non-joiners. This may have the
                                                                           effect of increasing take-up of the pension scheme.
8
Can a sacrifice be altered?                                                 Payroll
A salary sacrifice agreement will normally last for a period of 12 months   There’s no doubt that implementing a salary sacrifice arrangement
so that it fits in with salary reviews, for example. The agreement should   will have an administrative impact on the employer.
state that the variation to the contract of employment is time bounded
and that the old contract will be reinstated at the end of the salary       The employer will need to consider how existing computer systems
sacrifice period. And a new agreement should be signed every twelve         and any manual practices will be affected, if new procedures will be
months if the salary sacrifice is to continue.                              needed and what communication they will give to their employees.

   I
•	 	f a salary sacrifice lasts for less than 12 months, HMRC has            In appendix 4, we’ve replicated a payslip purely to highlight the
   suggested in their guidance that these cases should be referred to       salary sacrifice entry. Essentially, it appears as a negative salary
   their Employer Support Team.                                             amount. It shouldn’t appear as an entry under ‘deductions’.
                                                                            The description of the entry can be anything appropriate so the
   A
•	 	 n agreement may be altered within a salary sacrifice period if the     employee can identify it as a salary sacrifice amount for example,
   employee is subject to a ‘lifestyle event’ such as divorce, marriage,    ‘GPP Salary Sacrifice’.
   birth or adoption of a child or a change of employment.
                                                                            In appendix 5, we’ve included a process flow highlighting the
   I
•	 	n setting up the arrangement, the agreement could be worded             areas which we think employers will need to consider. This is not
   to allow the employee to revert to the original contract of              an exhaustive list and each pension arrangement will need to be
   employment if a ‘lifestyle event’ occurred. It would be up to the        considered on its own merits.
   employer to define this event, or events.
                                                                            Taking the next step
Salary sacrifice calculator                                                 If you would like to find out more about salary sacrifice or discuss
We’ve developed a salary sacrifice calculator, which initially will be      developing a communication strategy with employers, we can help.
available through your local Scottish Life contact. They will be able       For more information please get in touch with your usual Scottish
to demonstrate the benefits and advantages of salary sacrifice by           Life contact.
preparing ‘on the spot’ calculations for individual employees and
groups of employees.                                                        Where can I find out more?
                                                                            HMRC has extensive guidance on its website about salary
Some basic information will be needed such as the employee’s                sacrifice together with examples of successful and unsuccessful
name, sacrifice start date, salary, employee / employer contribution        arrangements. You can find this here:
rate (or monetary equivalent) and the basis for the salary sacrifice.       www.hmrc.gov.uk/manuals/eimanual/EIM42750.htm.

From this data, individual statements for each employee can be
produced and a summary sheet for the employer highlighting the
NIC savings is also available.




                                                                                                                                                   9
                                                                                                                          Appendix 1

Example agreement letter - sacrificing salary



[Date]




Dear [employee’s name]

Salary sacrifice

With effect from [day / month / year], your salary will reduce from [£x p.a.] to [£y p.a.] The monetary reward has been
reduced in lieu of an employer contribution to your pension arrangement.

By signing this letter you are confirming your agreement. Please sign both copies, keep one for your own records and
return the other copy to [employer’s name].

Yours sincerely




For and on behalf of XYZ Ltd                                               Date .......................................


I confirm I agree to this reduction in salary.




Signed .................................................................   Date .......................................




                    As this agreement constitutes a change to the employee’s contract of employment,
                                         we recommend legal advice be sought.




10
                                                                                                                          Appendix 2

Example agreement letter - sacrificing a contractual bonus



[Date]




Dear [employee’s name]

Contractual bonus sacrifice

With effect from [day / month / year], you will be entitled to a contractual bonus of [£x] of which you have agreed to
sacrifice [£y] in lieu of an employer contribution to your pension arrangement.

By signing this letter you are confirming your agreement. Please sign both copies, keep one for your own records and
return the other copy to [employer’s name].

Yours sincerely




For and on behalf of XYZ Ltd                                               Date .......................................


I confirm I agree to this contractual bonus sacrifice.




Signed .................................................................   Date .......................................




                    As this agreement constitutes a change to the employee’s contract of employment,
                                         we recommend legal advice be sought.




                                                                                                                                       11
                                                                                                            Appendix 3

Salary sacrifice process flowchart


 Adviser contacts           Adviser follow-up
 employer about             with employer
 salary sacrifice




 Employer considers                                     Employer contacts adviser
                            Employer receives
 setting up salary                                      and / or checks HMRC website
                            employer guide
 sacrifice arrangement                                  for more information




                            Payslip inserts,
 Employer considers         leaflet, noticeboard,
 communication strategy     announcement to
                            employees
                                                        Can employee start / stop / alter /
                                                        leave / rejoin the sacrifice at any
                                                        time ?
                                                                                              Employer considers
                            Employer considers
 Salary sacrifice                                                                             definition of pay, checks
                            payroll / HR implications   What about statutory benefits,
 arrangement set up                                                                           rules/policy provisions and/
                            and timescales              overtime, pay awards, P11D, death
                                                                                              or company / trustee policy
                                                        benefits, redundancy pay ?




 Employee considers         Employee receives
 joining arrangement        employee guide




 Adviser/Scottish Life      Employer issues
 prepares individual        statements to employees
 statements




                            Payroll / HR provides
 Employee requests          contact names, telephone
 more information           numbers, e-mail addresses




 Employee decides
 to join salary sacrifice
 arrangement




                            Sacrifice agreement
 Employee/employer sign     attached to contract of     Payroll notified                      Payslip alterations made
 sacrifice agreement        employment




 Employer provides          Employer sends copy of
 confirmation of            agreement to employee
 joining to employee




                            Employee receives
 HR/Payroll                 revised payslip with
 records updated            salary sacrifice entry




 Employer pays total
 contribution to pension
 arrangement


12
                                                                   Appendix 4

Sample payslip



                                     Company name


 Your name                                        Joe Bloggs
 Paid period                                      12
 NI number                                        AA 12 34 56 C
 Tax code                                         543L
 Employee payroll number                          00000001
 Employer tax office reference                    xxx / xx
 Contact telephone number                         01xxx xxx xxx


 Payments                                                 Amount

 Original Pay                                             £
 Salary Sacrifice                                       - £
 Pay after sacrifice                                      £

 Overtime                                                 £
 Bonus                                                    £

 Total                                                    £



 Deductions                                               Amount

 Tax                                                      £
 National Insurance                                       £


 Net Pay                                                  Amount

                           Bank account details
                           xxxxxxxxxxxxxxxxxx             £




                                                                                13
                                                                                        Appendix 5

HR/Payroll process flowchart



     Salary sacrifice
     arrangement set up




                               Copy of agreement
     Employer / employee       to employee, copy
     agreement signed          kept with Contract
                               of Employment




                               Record different salaries
     Notify payroll            for benefit payments




                               Manual records /
     Alter computer systems    computer system tweaks




                               Record sacrificed
     Alter employee payslips   amount as a negative
                               under ‘Payments’


                                                           Notify local tax inspector

                               Adhere to regulatory
     Deduct salary             timescales on
     sacrifice amount          contribution payments



                                                           Evidence :
                                                           1. pre/post sacrifice payslips
                                                           2. pre/post sacrifice contract of
     Pay to pension                                           employment
     arrangement                                           3. pension arrangement details




                               1. new entrants
     Mid year changes          2. lifestyle changes




                               Communicate options to
     Annual review             employees – increase /
                               decrease / opt-out




14
15
All literature about products that carry the Scottish
Life brand is available in large print format on
request to the Marketing Department. Full details
of Scottish Life branded products can also be
obtained from the Marketing Department at
Scottish Life, 19 St Andrew Square, Edinburgh
EH2 1YE.
Scottish Life is a division of Royal London and markets products produced by
Royal London. Royal London consists of The Royal London Mutual Insurance
Society Limited and its subsidiaries. The Royal London Mutual Insurance Society
Limited provides life and pension products, is a member of the Association of
British Insurers and is authorised and regulated by the Financial Services Authority,
registration number 117672. Royal London Marketing Limited acts as an insurance
intermediary for general insurance products and is authorised and regulated by
the Financial Services Authority, registration number 302391.

July 2008                                                                      SS1/2

				
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