Get smart about your pension

By SIMON MOON
Updated: 10:42 EST, 26 October 2007

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COMPANIES are getting smart in their search for ways of keeping their pension schemes alive. Rather than reducing benefits or telling staff they will have to work longer, more businesses are promoting a different approach – the smart pension.

This is a new name for an idea that has been around for some time under the heading of salary sacrifice. This is how it works:

Both the employer and the employee continue to contribute to the company scheme, but the employee does so by taking a pay cut equivalent to the amount that would normally come out of their pay packet.

While this leaves employees no better or worse off, it can produce big savings for the company by reducing the amount of National Insurance it has to pay, because this is based on individual salaries.

The company can use some or all of this saving to top-up its contribution at no extra cost to itself.

Trade union Amicus, which has more than a million members, says careful account needs to be taken of all pay-related benefits to ensure they are not reduced by salary sacrifice.

'The best way of dealing with these is for it to be established that they will continue to be calculated by reference to what salary would have been had the salary sacrifice not taken place,' it says.

'Where members are in schemes where the amount of pension is defined by reference to final salary, then a similar safeguard needs to be introduced. Otherwise there could be a big impact on the value of past and future service pension entitlements.'

Des Hamilton, technical director at the independent Pensions Advisory Service, warns the arrangement could affect entitlement to the State Second Pension (S2P). This is paid as a top-up to the basic pension and is related to your earnings.

'You are automatically entered into this scheme but once you join some company schemes you cease to be a member of S2P. This process is known as contracting out and the literature from the Smart Pension should tell you if that scheme is contracted out,' he says.

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Money purchase company schemes, which are not based on final salary, are likely to be contracted into S2P. So salary sacrifice could cut your S2P entitlement. This is something to discuss with your employer.

HM Revenue & Customs (HMRC) says the employee's previous gross salary remains the yardstick for issues such as the calculation of overtime pay, annual salary increases or salary- related benefits.

HMRC adds that employees who do not opt out when a company switches to salary sacrifice must wait until the first anniversary of the start of the scheme for another chance to opt out, unless they experience a 'lifestyle change' such as marriage, birth of a child, separation or divorce, or change from full-time work to part-time.

Further information: Pensions Advisory Service advice line: 0845 601 2923