The unexpected price of pension salary sacrifice during Covid-19 


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Many pension schemes operate on a salary sacrifice basis for very sensible reasons. However salary sacrifice can have unwelcome consequences for employers during Covid-19.  For many, it has led to a significant increase in liability. In this Q&A, we look at the employer obligations and their options where their schemes use salary sacrifice. 

How does a pensions salary sacrifice arrangement work?
In a pensions salary sacrifice arrangement staff agree to reduce their earnings by an amount equal to their pension contributions.  In exchange, the employer pays the total pension contributions.  Any contributions paid to the pension scheme will be treated as exclusively employer contributions.
How does salary sacrifice impact what employers can recover from the Coronavirus Job Retention Scheme (CJRS)?
The reference salary for calculating the CJRS wage grant is based on the individual's salary at 19 March 2020, after the salary has been sacrificed.  So a salary sacrifice arrangement will effectively reduce the reference salary and, in turn, the grant payable.
This has a knock on impact on the amount of pension contributions that can be recovered from the CJRS by the employer.  It will be limited to the statutory minimum employer contributions (ie 3% of qualifying earnings) based on the grant paid by the furlough scheme.  
However the pension contribution due to the scheme will continue to be based on the salary before it has been sacrificed. This means that, in practice, employers with salary sacrifice arrangements will be able to recover a smaller percentage of pension contributions from the CJRS relative to the employee's salary compared to schemes that do not use salary sacrifice.  
What happens if an employer reduces staff salary?  
Many employers have reduced or are considering reducing staff salaries during Covid-19.  Regardless of whether the individual is on furlough, the salary sacrifice arrangement remains intact.  This means the employer must continue to pay the full pension contribution which, under most scheme rules, will be based on the actual pay being received.  
If, for example, the employer pays 12% of salary (of which the employee has contributed 6% by way of salary sacrifice), the employer must continue to pay 12% of salary based on the new pay. 
Can employers continue to operate salary sacrifice where salary is reduced?
For staff not on furlough, the employer will be able to continue to operate salary sacrifice in the usual way.  However, for those on furlough, the employer can only sacrifice salary (if any) that is paid in addition to the grant paid by the CJRS.  This is because the grant received from the CJRS cannot be sacrificed as it must it must be paid in full as cash to the employee.  
This means that if the employee's pay is limited to the grant from the CJRS, the employer cannot reduce any of his or her wages under the salary sacrifice arrangement.  The employer must therefore, based on the example above, pay the full 12% of salary to the pension scheme despite not being able to recover the member's element of the contribution from salary.  In this scenario, the salary sacrifice arrangement has effectively doubled the employer's contribution obligation and potentially significantly increased overall liability. 
By contrast, this issue does not arise where salary sacrifice is not used as member contributions would continue to be payable (along with NIC and tax) from the pay received.  
How should employer contributions be calculated where staff only receive the grant paid by the CJRS? 
To add further to the employer's woes, where salary sacrifice is used, the amount on which the employer pension contribution should be based will be the notional pre-sacrifice amount received from the CJRS.  So if the employer receives, for example, £2,500 from the CJRS, the employer pension contribution should be based on the notional pre-salary sacrifice amount applicable for £2,500.  The employer will first need to calculate what this notional amount is and then the correct contribution. 
What can employers do to protect again these unexpected liabilities?
Employers can consider the following options:
  • Reduce the contribution due
Employers can reduce the contributions provided the scheme remains auto-enrolment compliant.  This may ¬need employee consent (where the contributions are contractual and/or it requires changes to the salary sacrifice arrangement) and consultation with the affected staff for 60 days.  
Helpfully, if the change only impacts those on furlough and the contribution will go back up once staff stop being on furlough, the Regulator has said that it will not take action for failing to consult for the full 60 days.  This is provided staff have been consulted for as long as possible and the change has been clearly and carefully explained to them.  This "easement" is to remain in place until 30 June 2020, although is subject to ongoing review. 
Employers will need to check whether the reduction is within the scope of the scheme rules and make any amendments that may be required.  
  • Stop the salary sacrifice arrangement
The employer will need to bear in mind that the salary sacrifice arrangement is contractual so any change should ideally be done with employee consent to reduce the risk of claims.  In addition, stopping a salary sacrifice arrangement will usually mean a reduction in the employer contribution due to the scheme and the introduction of member contributions, both of which may trigger the obligation to consult for 60 days.  It may also require an amendment to the scheme rules.
Can staff opt out of salary sacrifice during Covid-19?
HMRC has confirmed that Covid-19 would constitute a life event that would allow staff to opt out of a pensions salary sacrifice arrangement.  
However, the Pensions Regulator has said opting out after 19 March would not increase the reference salary for the purposes of what can be recovered under the furlough scheme.  Therefore, opting out is only likely to be in the employee's interest where the employer is topping up salary beyond what is being recovered from the government scheme.  
What is the key take away for employers?
Having a salary sacrifice pension arrangement can lead to an unexpected and significant increase in liability where changes are made to staff salary and pensions during Covid-19.  Therefore, before making any decisions, employers should carefully analyse the pensions implications and understand what their options are to reduce any associated increase in costs.
If you have any questions on anything in this bulletin, please do contact one of our pensions team who would be delighted to help.
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