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Salary Sacrifice for Doctors and the NHS Pension Scheme

Salary Sacrifice is an arrangement that the NHS has made available to all employees where the employee agrees to formally (that is, contractually) reduce their salary. Salary sacrifice arrangements in Scotland will not reduce pensionable pay and therefore the guidance below, as it relates to pension implications is for members of the NHS in England, Wales and Northern Ireland.

From 6 April 2017, the Government removed any tax and national insurance advantages for salary sacrifice schemes, except in five areas where such arrangements can be made. These are:

  • increasing employer pension contributions to registered pension plans (eg buying additional pension)
  • an employee securing advice on their pension
  • employer supported childcare consisting of either:
    • childcare vouchers provided by the employer for qualifying childcare, (only applicable to those employees who joined the relevant scheme prior to 4 October 2018)
    • directly contracted or employer contracted childcare, where the employer directly arranges for the provision of qualifying childcare
  • cycle to work schemes
  • ultra-low emission cars (emissions under 75 grams of CO2 per kilometre).

Using the above salary sacrifice arrangements means that both the employee and the NHS pay less in National Insurance Contributions.

As the employee has reduced their earnings, it means that tax relief on pension contributions cannot be claimed as the contribution is made by the employer, instead the benefit is realised through the salary sacrificed not being taxed.

The reduction in salary will also have an impact on how peripheral benefits are calculated, such as death in service cover and Ill Health Retirement benefits, which will be based on the post-sacrifice (reduced) salary.

It is important to remember that salary sacrifice arrangements will affect the individual employee’s terms and conditions of employment, and that they are governed by employment law, not tax or pensions law.

One of the features of the NHS Pension Scheme (NHSPS) for members is the option to sacrifice some of their salary in exchange for different (non-pension) benefits, such as cycle schemes and car lease programmes.

It’s easy for members to see the potential cost to them in terms of the salary to be sacrificed and the estimated net monthly cost, accounting for tax savings. However, it only shows the position from an Income Tax perspective – importantly it does not account for the impact it may have on the member’s pension.

Salary sacrifice will reduce the pensionable pay when calculating NHS pension benefits and it is important that Doctors understand the effect on their pension benefits and the potential tax charges associated with their NHS pension scheme.

The impact on their pension will depend on which scheme section they are in. Detailed below is an overview of the impact and considerations for each section.

The 1995 pension scheme for Officers is a final salary basis scheme which means that if the member sacrifices pensionable pay to take advantage of a car lease arrangement, it will likely lead to a reduction in pension benefits, followed by a marked ‘spike’ in the year the car lease arrangement ends.

This spike can lead to Annual Allowance complications when the sacrifice arrangement ends, especially where the salary sacrifice term spans more than 2 years.

Best pensionable pay in the last 3 years

When calculating the Annual Allowance, the scheme calculates benefits on the basis the member retired on the calculation date, without any early retirement reduction factors.

In calculating the 1995 pension benefits, the NHS use the best pensionable pay in the last 3 years. Therefore, should the member experience a drop in pension benefits due to salary sacrifice, this will not automatically result in their benefits being reduced in year 1. You need to be aware that on occasions errors occur and the NHS Business Service Authority fails to use the best pensionable pay in the last 3 years which will result in an immediate drop in pensionable pay. When this occurs, it will need to be corrected.

The actual reduction in calculating benefits is likely to occur at the end of year 3, once the pensionable pay prior to the salary sacrifice no longer falls within the last 3 years.

Pension Increases – Consumer Prices Index (CPI)

There is also the added complication of pension increases in payment applying from the “end of the pensionable pay period used”.

As the benefits for the purposes of Annual Allowance are calculated assuming the member retired on the calculation date, if an earlier year is used, it may result in the pension benefits receiving pension increases between the end of the pensionable pay period used (before the salary sacrifice) and the calculation date.

Pension Increases are applied the first Monday following the end of the tax year, therefore for Annual Allowance purposes this is only applied where the best of the last 3 years’ pensionable pay is from the earliest year.

The following table highlights how the best of the last 3 years will impact on the calculation over a 3-year salary sacrifice term, with a pensionable pay of £150,000 and £8,000 sacrificed.

YearActual Pensionable payBest of last 3 yearsNotes
Year before salary sacrifice£150,000£150,000No reductions have occurred yet, therefore the actual pensionable pay is used
1st year salary sacrifice£142,000£150,000The best pensionable pay will be from the year before the salary sac.
2nd year salary sacrifice£142,000£150,000The best pensionable pay will be from the year before the salary sac.  
However, as the earliest year has been used in this calculation, pension increases (CPI) will also be applied to the benefits.   Therefore, the benefits in this example will be calculated based on £150,000 but will also receive CPI increases applicable at the end of the first year.
3rd year salary sacrifice£142,000£142,000The year before salary sacrifice is no longer within the last 3 years, as such pension benefits are now calculated on the lower pensionable pay of £142,000
Year after salary sacrifice£150,000£150,000The salary sacrifice has ended, and pensionable pay reverts.   This sees an increase in pensionable pay of £8,000 for purposes of calculating benefits and may lead to an increased Annual Allowance tax charge.
Increases in Pensionable Pay

As covered above, the best pensionable pay of the last 3-years will be used in order to calculate the member’s benefits. However, should the member experience an increase in pensionable pay during the salary sacrifice term this can have an impact on the Annual Allowance tax charges experienced over the period.

An increase in pensionable pay during the salary sacrifice term can actually lead to a lower overall tax charge over the period, compared to not electing for a salary sacrifice. This will depend on the amount of the increase compared to the salary sacrifice reduction, along with when this increase occurs.

For this reason, when considering a salary sacrifice it is imperative that the member considers what their expected pensionable pay will be in the coming years, including any known increases, which could be in relation to Clinical Excellence Awards, or increases in basic pay.

The 2008 scheme uses the best 3 consecutive year average of the last 10 years allowing for pension increases (CPI). Therefore, unless the best 3-year period is the most recent, it should not affect the reckonable pay when calculating the Annual Allowance.

However, it is important to remember that in the future when calculating reckonable pay, this 3-year period will always have a lower pensionable pay, which could have an impact on retirement figures for up to 10 years after the salary sacrifice has finished.

As the reckonable pay is calculated making an allowance for the pension increases (CPI), generally speaking, the best 3 consecutive year period is not the most recent, unless the member has seen a significant increase in pensionable pay that is greater than inflation over the same period.

The 2015 pension scheme is a Career Average Revalued Earnings (CARE) scheme. This basis of calculating benefits means benefits are calculated based on the earnings each year, rather than using final pensionable pay.

If a member sees a reduction in their pensionable pay in a year, this will have the result of permanently reducing their pension benefits. This is an important point as the reduction will not be replenished at the end of the salary sacrifice period as is the case under the 1995 pension scheme.

Over a number of years this reduction can amount to a significant benefit lost and should be considered against the savings made by the salary sacrifice arrangement.

In terms of Annual Allowance, input amounts are reduced if the pensionable pay is lower, this is likely to lead to lower tax charges over the period of the arrangement.

Once/if the salary sacrifice ceases, pensionable pay will go back up however, the increase will not be applied to the entire service and as such the input will be higher in the year pay goes back up. It should not however create a ‘spike’, as referenced under the 1995 pension scheme.

Salary Sacrifice Term

A crucial component of the 1995 benefits and the best pensionable pay in the last 3 years calculation is the term selected for the arrangement.

Where a 3-year term is selected, the member will experience a drop in pensionable pay in year 3 (assuming no increases in pensionable pay). This will then result in a ‘spike’ when the salary sacrifice ends.

However, should the salary sacrifice arrangement be taken over a shorter period (2 years for example), they would not necessarily experience the fall in pensionable pay in the 3rd year and thus avoid the ‘spike’ following the end of the arrangement.

Should the salary sacrifice arrangement continue up to the member’s retirement date, their 1995 benefits will be permanently reduced. There may also be a continued reduction in the 2015 pension benefits.

Annual Allowance – Carry Forward

Whilst there are considerable implications for the Annual Allowance, it is important to not look at each of these years in isolation.

Members have the ability to carry forward unused allowance from the previous 3 years. This available allowance may reduce or remove the impact of the ‘spike’ following the end of the arrangement.

It is therefore important for members to complete a full review of their Annual Allowance position.

Key points
  • The best of the last 3 years will play a part in the calculation as demonstrated above.
  • This could potentially reduce the input amounts for the period; however, it has the potential to cause a significant spike in the year salary sacrifice ceases.
  • Changes in pensionable pay during the period need to be accounted for. An increase in pensionable pay during the period could impact on the Annual Allowance calculation.
  • The ‘spike’ in pensionable pay will not simply be the amount of salary sacrificed, as the opening pension value will be increased by inflation.
  • The timing of the salary sacrifice may also impact on the annual allowance calculation. Starting the arrangement part way through the year will mean the pensionable pay calculation will be apportioned when calculated at 5 April. This will lead to differing figures over the term.
  • If the member sees a jump up in pensionable pay during the salary sacrifice period, this could result in a lower input amount during the period
  • A 2-year lease could be fully covered with best of last 3 years’ calculation, avoiding the spike at the end of the salary sacrifice term.
  • Members will experience a permanent reduction in their 2015 pension benefits which could amount to a significant loss over a number of years, outweighing any savings made from the arrangement.
  • It is important to remember that individuals will still have Annual Allowance available, along with any unused carry forward, which they can utilise to cover any spikes.
Chase de Vere Medical view

Participating in a salary sacrifice arrangement can provide some valuable benefits to some members of the NHS pension scheme however, it is important that consideration is given to the impact the decision may have on NHSPS pension benefits. Not taking the impact, or potential impact into account means the member could be susceptible to additional tax charges for their 1995 scheme benefits, or worse still, a permanent reduction in their 2015 benefits, which could cost a substantial amount to replicate.

Where a salary sacrifice arrangement term of 3 years is selected, assuming no pensionable pay increases, a member is likely to see a ‘spike’ in pension benefits once the salary sacrifice ceases, which will lead to an increased pension input amount. This spike is likely to lead to additional tax charges, which could negate the benefit of entering into the salary sacrifice arrangement in the first place.

We have explained how increases in pensionable pay could lead to lower tax charges by applying for salary sacrifice, however, it is important to remember that there is also the permanent reduction in the 2015 scheme benefits which needs to be taken into consideration.

Our view is best summed up in the adage “just because you can, doesn’t mean you should”. Doctors need to think very carefully before applying for salary sacrifice as the effect on pension growth and the increase in annual allowance tax charges can considerably outweigh any potential saving. There is no universal answer, the impact, as we have explored above, will depend on a range of specific factors:

  • Pensionable Pay changes
  • Consumer Prices Index (CPI)
  • Scheme (1995, 2008, 2015)
  • Term of the lease/Salary Sacrifice arrangement
  • Amounts involved
  • Carry forward
  • Total income
  • Expected salary increases

One thing is clear that it is imperative that doctors seek professional financial advice prior to making any decisions.

Content correct at the time of writing and is intended for general information only and should not be construed as advice.

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