LGPS and AVCs via salary sacrifice
12 January 2018
This article was featured in the February 2018 issue of the magazine.
Amanda Venables, senior manager, employee benefits at PSTAX, explores how a salary sacrifice arrangement can be used to provide a cost saving benefit to employees who are members of the LGPS and wish to pay AVCs
Readers will be aware that members of the Local Government Pension Scheme (LGPS) can elect to pay additional voluntary contributions (AVCs) to increase their pension benefits at retirement. AVCs are an efficient way to save for retirement because they attract full tax relief.
However, many employers are unaware that, in accordance with the terms of the LGPS, where an employee opts to pay AVCs the employer can also contribute to the employee’s AVC fund. This is known as a shared cost AVC (SCAVC) arrangement, which can be provided through a salary sacrifice arrangement.
Under the SCAVC salary sacrifice arrangement, an employer can agree to pay an employee’s chosen contribution amount to their AVC fund and, in return, the employee agrees to enter a salary sacrifice arrangement under which he/she accepts a reduction in gross salary, which is equal to the contribution amount. In addition, the employee is required to pay a fixed £1 a month as their individual contribution to the SCAVC arrangement. This contribution is deducted from the employee’s gross salary and paid into the AVC fund in addition to the contribution from the employer under the salary sacrifice arrangement.
For employees who pay income tax and National Insurance contributions (NICs), the advantage is that they will not pay tax or NICs on the amount salary sacrificed. As a result, operating a SCAVC through a salary sacrifice arrangement provides an opportunity for employees to save NICs in addition to the usual tax savings, thus increasing take-home pay when compared to paying AVCs in the standard way. (See Example.)
John’s salary is £25,000 per year and he currently pays £3,000 in AVCs per year.
As John is a basic rate taxpayer, he currently receives £600 tax relief on the AVC payments. Therefore, John’s current annual net AVC cost is £2,400 (i.e. £3,000 - £600).
If his employer provides a salary sacrifice SCAVC arrangement and he agrees to a sacrifice of £2,988 and pays £12 per year in AVCs (resulting in a total contribution of £3,000), he will still make £600 in tax savings. In addition, he will benefit from NICs savings of approximately £358 per year (£2,988 × 12% at current rates). So, by participating in the salary sacrifice SCAVC arrangement, the actual net cost to John of the £3,000 contribution will be £2,042 (£3,000 - £600 - £358).
Therefore, when compared to paying standard AVCs, participation in the salary sacrifice SCVAC arrangement results in an annual net saving to John of £358.00.
John can keep this saving, or he can choose to put it into extra AVCs and make further tax and NICs savings, thus increasing the amount paid into his AVC pot.
...opportunity for employees to save NICs in addition to the usual tax savings...
In addition, the employer will benefit from a reduction in secondary class 1 NICs that it is required to pay. For example, if 200 employees participate and sacrifice an average £1,200 per year, the employer can expect to generate annual NICs savings of around £33,120. The available savings may also act as an incentive to others to join the scheme thus creating additional savings in due course.
Operating a SCAVC by means of a salary sacrifice arrangement is growing in interest within the public sector and is not affected by the legislative changes relating to the withdrawal of tax and NICs advantages of certain benefits provided through salary sacrifice.
As a result of new legislation (optional remuneration arrangements) introduced in April 2017, certain benefits provided through salary sacrifice are now treated as taxable benefits in kind. This change in legislation impacts on many popular benefits including car parking, work-related training, computers and technology goods and, as a result, many employers are likely to cease providing such benefits through salary sacrifice. As the benefit of pension (including AVCs) is not affected by the legislation, introducing a salary sacrifice SCAVC scheme can provide employers with a good opportunity to maintain its employee benefits offering.
With this type of arrangement great care should be taken to ensure that all tax/NICs aspects are carefully considered and it is strongly recommended that appropriate advice is taken. As with any salary sacrifice scheme, it is imperative that there is a proper contractual change to the employees’ terms and conditions of employment in order to satisfy HM Revenue & Customs’ requirements.
It is also important that all implications – in addition to the effect on tax/NICs – are fully communicated and understood by employees, such as the effect on statutory payments (e.g. statutory sick or maternity pay), overtime and when AVC benefits can be taken.