Tax Matters: Auto-enrolment a unique and tax-efficient way of providing for future retirement

THE automatic enrolment of employees into workplace pension schemes finally begins next week after years of planning. It also brings with it new opportunities to reduce the amount of tax you pay from your salary.

That’s because HM Revenue & Customs (HMRC) has, in conjunction with the reforms, introduced a more relaxed interpretation of what is a valid “salary sacrifice” pension scheme in order to both increase employer pension contributions and assist with the payment of them.

There seems little doubt that both employers and employees should take advantage of the changes and make savings under auto-enrolment. In general terms, salary sacrifice schemes can produce tax and National Insurance savings for employers as well as employees.

The way salary sacrifice schemes work is that a part of your salary is paid dir­ectly to your pension plan by your employer, rather than being paid to you. As a result, you will have a lower taxable salary, and both you and your employer pay less National Insurance contributions. (NICs). As a part of the deal, your employer should pay all or part of their NIC saving to your pension plan, along with the sacrificed amount.

Let’s look at an example. If you earn £40,000 a year and decide you want to salary sacrifice £1,000, your new salary becomes £39,000 and your employer pays £1,000 to your pension fund. It means that you will pay less in NICs (and, in some cases, less income tax) because your salary is lower.

Your employer also pays less NICs but must pay all or a part of that saving to your pension scheme. Apart from the fact that you will pay less national insurance (and possibly tax) the major benefit is that your retirement plan will receive a boost because of the addition to your pension pot of a proportion of your employers NIC saving.

The intention of automatic enrolment into company pension schemes is to make the whole process of starting your pension fund a lot simpler; in effect you will be automatically enrolled into the schemes, with the added attraction that the employer company must contribute to them.

In order to retain flexibility there is an “opt out” clause whereby any employee can decide to withdraw should they feel that the scheme could cause financial hardship to them in the short term, or if they would prefer to start a private scheme, however the longer term objective is to make for a more comfortable standard of living on retirement.

Auto-enrolment will initially only involve the employees of large companies before it is extended to all but the smallest employers over the next few years.

The pension schemes can be operated alongside salary sacrifice schemes which will help employers to defray some of the additional cost associated with the requirement to contribute under the auto-enrolment rules.

The difficulties which future generations will face in financing their lifestyles through pension savings have been well documented in the past and there is little doubt that this latest initiative presents a unique and tax-efficient way of providing for future retirement in a world where state retirement benefits alone would leave most people below the poverty line.

Where a salary sacrifice scheme is being considered, specialist advice must be taken both in drawing up the scheme rules and seeking approval from HMRC.

• Ronnie Ludwig is a partner at Saffery Champness chartered accountants in Edinburgh