We have written previously about how employees exchanging part of their salary and/or bonus for increased pension contributions has become common.
We explained how this can be far more attractive than the employee making a direct pension contribution on his/her own behalf.
Attractions of salary sacrifice
Contributions paid out of an employee’s after-tax pay are less attractive as the employee (and the employer) will have paid NI contributions, and the new 1.25% Health & Social Care Levy, on the gross income received.
If instead, the employee can agree with their employer to sacrifice salary/bonus equivalent to the desired pension contribution there will be the following advantages when that amount is paid as an employer contribution. This can result in a 37.9% increase in the pension contribution of a basic rate taxpayer (Previously 33.88% before the recent tax rises). For 40% and 45% taxpayers, the increases are 21.7% and 22.3% respectively (Previously 17.7% and 18.05%).
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 |
1,151 |
Employer NI contribution (13.8%) |
138 |
Nil |
Health & Social Care Levy (1.25%) |
12.5 |
Nil |
Total employer outlay |
1,151 |
1,151 |
Employee salary |
1,000 |
Nil |
Less income tax |
(200) |
|
Less NI contributions (12%) |
(120) |
|
Less Health & Social Care Levy (1.25%) |
(12.5) |
|
Net pay = pension contribution |
668 |
|
Tax relief @ 20% |
166.88 |
|
Total pension contribution |
834.38 |
1,151 |
The second and third example is of 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 |
1,151 |
1,151 |
Employer NI contribution (13.8%) |
138 |
138 |
Nil |
Nil |
Health & Social Care Levy (1.25%) |
12.5 |
12.5 |
Nil |
Nil |
Total employer outlay |
1,151 |
1,151 |
1,151 |
1,151 |
Employee salary |
1,000 |
1,000 |
Nil |
Nil |
Less income tax |
-400 |
-450 |
||
Less NI contributions (2%) |
-20 |
-20 |
||
Less Health & Social Care Levy (1.25%) |
-12.5 |
-12.5 |
||
Net pay = net pension contribution |
566 |
516 |
||
Tax relief |
377.18 |
422.00 |
||
Total pension contribution |
943 |
938 |
1,151 |
1,151 |
A taxpayer could also see a benefit in terms of reducing or eliminating the high-income child benefit charge on income above £50,000. For taxpayers with income between £100,000 and £125,140, salary sacrifice planning can also be used to reclaim the personal allowance in addition to the income tax and NI savings.
There will also be no need to claim tax relief via your tax return if you are a higher or additional rate taxpayer.
Conditions for a successful salary sacrifice
It is important to note that the salary sacrifice will be effective for all purposes and to be effective it must comply with the criteria set out in the ‘Employment Income Manual’ issued by HMRC. For a salary sacrifice to be effective it must be made before the remuneration being given up is treated as received for employment income tax purposes. For an employee this will normally be the earlier of:
- the date the payment is made, and
- the time the individual becomes entitled to the payment.
Other considerations
If you are working out whether salary sacrifice is right for you, it is important to consider the impact the salary sacrifice may have on other areas. For example, your death in service may reduce if you lower your salary. You may find it harder to get a mortgage if your salary falls.
Another consideration is that rules may change in the future. As soon as the tax changes were announced stories in the papers were commenting on how salary sacrifice could be next.
If you want to talk about anything, feel free to book a free no-obligation chat here.
