It has become common practice for employees to exchange part of their salary and/or bonus in return for their increasing the pension contribution they pay by the same amount.
This can be far more attractive than the employee making a direct pension contribution on his/her own behalf, particularly if the employer is prepared to increase their pension contribution by part or all of their national insurance (NI) contribution saving.
Attractions of salary sacrifice
Contributions paid out of an employee’s after-tax pay are less attractive as the employee (and his/her employer) will have paid NI contributions 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 33.88% increase in the pension contribution of a basic rate taxpayer. For 40% and 45% the increases are 17.7% and 18.05% respectively.
Example 1: 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% |
120 |
|
Net pay = pension contribution |
680 |
|
Tax relief @ 20% |
170 |
|
Total pension contribution |
850 |
1,138 |
Example 2: 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 13.8% 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 |
1,138 |
Employer NI contribution (13.8%) |
138 |
138 |
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 |
387 |
434 |
||
Total pension contribution |
967 |
964 |
1,138 |
1,138 |
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.
