We have written previously about how it’s become common for employees to exchange part of their salary and/or bonus for increased pension contributions.
We previously discussed how this way of saving for retirement may be more attractive than simply contributing as an employee.
Attractions of salary sacrifice
When an employee pays contributions from their after-tax income, it may not be the best option. This is because both the employee and employer will have paid National Insurance contributions on the total income received, making it less attractive.
If an employee agrees with their employer to reduce their salary or bonus, they can increase their pension contribution. This can result in a 35% increase in the pension contribution for a basic rate taxpayer (previously 38%). For 40% and 45% taxpayers, the increases are both around 21% (previously 22%).
The first example is that of a 20% taxpayer:
|
|
Personal contribution |
Salary sacrifice employer contribution (sacrificed amount + NI saving) |
Tax rate |
20% |
20% |
|
|
£ |
£ |
Gross salary |
1,000 |
Nil |
Employer pension contribution |
Nil |
1,138 |
Employer NI contribution (13.8%) |
138 |
Nil |
Total employer outlay |
1,138 |
1,138 |
Employee salary |
1,000 |
Nil |
Less income tax |
-200 |
|
Less NI contributions (12%) |
-100 |
|
Net pay = pension contribution |
700 |
|
Tax relief @ 20% |
140 |
|
Total pension contribution |
840 |
1,138 |
The second and third examples represent 40% and 45% taxpayers. This example shows the amount of contribution that could be paid, either as a direct employee contribution or via salary sacrifice, assuming the employee is a 40% taxpayer, and the employer is prepared to increase the salary sacrifice pension contribution by their NI contribution saving. This is based on £1,000 gross salary and assumes the Annual Allowance is not an issue.
|
|
Personal contribution |
Salary sacrifice employer contribution (sacrificed amount + NI saving) |
||
|
|
£ |
£ |
||
Tax rate |
40% |
45% |
40% |
45% |
Gross salary |
1,000 |
1,000 |
Nil |
Nil |
Employer pension contribution |
Nil |
Nil |
1,138 |
11,138 |
Employer NI contribution (13.8%) |
138 |
Nil |
Nil |
Nil |
Total employer outlay |
1,138 |
1,138 |
1,138 |
1,138 |
Employee salary |
1,000 |
1,000 |
Nil |
Nil |
Less income tax |
-400 |
-450 |
||
Less NI contributions (2%) |
-20 |
-20 |
||
Net pay = net pension contribution |
580 |
530 |
||
Tax relief |
232 |
238.5 |
||
Total pension contribution |
943 |
938 |
1,138 |
1,138 |
If your income is over £50,000, you may be charged for high-income child benefit. However, there’s a way to reduce or eliminate this charge. If your income falls between £100,000 and £125,140, you can reclaim your personal allowance through salary sacrifice planning. This can also help you save on income tax and national insurance contributions.
If you’re a higher or additional rate taxpayer, you won’t need to claim tax relief via your tax return.
Conditions for a successful salary sacrifice
It’s worth noting that to be effective, a salary sacrifice must meet the criteria set out in the ‘Employment Income Manual’ issued by HMRC. To achieve this, the sacrifice must be made before the remuneration being given up is treated as received for employment income tax purposes. This is usually before the payment is made, or when the individual becomes entitled to the payment.
Other considerations
If you’re thinking about salary sacrifice, it’s important to consider how it may affect other areas of your life. For instance, your death in service benefit may be reduced if you lower your salary, and it may be harder to get a mortgage if your salary falls.
It’s also worth keeping in mind that rules may change in the future.
So salary exchange has become a little less attractive but is still a good way to save for retirement. If you want to talk about anything, feel free to book a free no-obligation chat here.
