Payroll Advice

What's so smart about smart pensions

Pensions can be filled with pitfalls for the unwary. Catch up with all you need to know about smart pensions.

A number of schemes (and also scams) are often promoted around Human Capital Management arena, often with major impacts on payroll managers and payroll operations with consequences on Tax and National Insurance application & contributions.

One such scheme is marketed as the "Smart Pension Scheme" but what it really is, is a traditional salary-sacrifice arrangement, which works by the employee giving up an amount of cash pay (often by the same amount as previously contributed) which is then paid by the employer. Occasionally these employer contributions are enhanced to be more than the sacrificed amount to reflect the employer saving – but don’t hold your breath.

Smart Pension Schemes go one stage further, as the employees are notified that the new arrangement will automatically apply from a particular date, unless the employee chooses to opt out in advance.

Often the arrangement is made so that if an employee does not opt out at the start, then they cannot choose again until one year later - unless they experience what is often referred to in the flexible benefits world as a “Lifestyle Change”. This would mean: marriage; the birth of a child; divorce or separation; death of a spouse, partner or child; or the a change in employment status, such as full-time to part-time work.

Often the employee’s original gross pay (the base or notional pay) remains the calculation basis for other pay elements such as: overtime, pay increases, or other salary-related benefits.

The "Big Win" for the employer and often for the employee is that, if effective, the scheme reduces the Class 1 NICs liability which is now payable only on the reduced pay. And no Tax or NICs liability arises on the employer contributions to the pension scheme.

As these schemes are on the increase and forming part of flexible benefit products and services, the HMRC sought legal advice, which confirms that the Smart Pension Scheme can be effective in reducing the NICs liability of the employers and employees who decide to participate.

Some questions may be asked as to how these schemes can be a variation of an employee’s terms and conditions as required by salary sacrifice to be effective, as the employee does not have to sign a document signifying their revised terms and conditions of employment! HMRC have accepted that this and similar schemes are clearly intended to vary the terms and conditions of employment of all employees, except those who opt out: as this is made known to all employees in advance of the scheme being introduced. By not opting out, the employee accepts the reduced salary payment without objection, and therefore accepts the variation to their contract.

In February 2005, HMRC issued guidance on the representation of the salary sacrifice arrangement and its reflection on the pay advice or pay slip. Having listened to payroll industry representation, HMRC now accepts that pay advice does not need to reflect an actual cut in pay as long as the contractual change can be shown to be effective by documentation held by the employer.

HMRC agrees that using the “base salary” for such purposes is compatible with a genuine reduction in the employee’s contractual pay. The essential element for salary sacrifice to be effective is whether the terms and conditions of employment have been varied to reduce the cash pay. Where this is the case then the employee will not be able to sue their employer for the original level of salary or consider an illegal deduction from wages.

But be warned! Don’t just assume that our friendly tax inspector will ignore such schemes at face value: they will be interesting in checking that such schemes have been properly implemented, to give effective variation to terms and conditions of employment.

Types of checks:

• Have the necessary rule changes been made to the actual pension scheme to reflect the cessation of employee contributions and the increase in employer contributions
• The notification distributed to participants of the operation of the new contractual arrangement
• It should also be confirmed that changes are reflected on the Pay Advice, PAYE records, etc.

So are these schemes new? No. The very first application of Salary Sacrifice arrangements related to Pension Scheme contributions, often by giving up entitlements to annual bonus in preference for employer contributions to pension schemes.

Are they on the increase? Yes. Flexible benefit schemes are increasingly being made available to employees, no matter what their size of employer. And with the intended increase to UEL, they will become increasingly more popular in the future.

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