Using salary sacrifice to put a priority on pensions

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For employer and intermediary use only

 

Back in 2017, the government reduced the number of employee benefits that would have previously attracted tax savings when arranged through salary sacrifice schemes.

The great news is that using salary sacrifice for pension contributions wasn’t affected.

How can employees boost their take-home pay or pension savings through salary sacrifice?

The challenge for employers, with the help of their advisers, is to educate and remind employees that employer pension contributions are not a taxable benefit subject to income tax and national insurance (NI), and so it is possible for them to either;

  • pay a lower gross salary and a higher pension contribution for their employees, or
  • maintain the same pension contribution and increase the take-home pay of their employees.

Even though the employee sacrifices some of their gross salary, they do not lose out financially because they can either see an increase in the pension contribution being made or an increase in their take-home pay - depending on how the salary sacrifice is structured.

The worked examples below show how a salary sacrifice arrangement, based on a UK taxpayer rather than Scottish taxpayer, could work in practice and will help employers and employees decide whether such a scheme could work effectively for them.

There are four examples and these have been prepared based on the following assumptions:

Example 1

This example ‘keeps the pension contribution constant’.

The employee sacrifices some of their gross salary so that, after sacrifice, the personal contribution is altered to an employer contribution of the same amount and the employee’s take-home pay is increased. Assume a 40-year-old employee is earning £30,000 pa (so is a basic rate taxpayer) and is contributing £150 per month as a personal contribution before salary sacrifice. Simply using salary sacrifice means they can increase their take-home pay by £364.43 each year whilst maintaining the same pension contribution, which switches to being paid by the employer after sacrifice. This is as a result of paying less tax and NI on the reduced salary after sacrifice of £28,418. There’s no additional cost to the employer who is passing on the full benefit of their (13.8%) NI saving to increase the employee’s take-home pay.

Example 1
  Before sacrifice After sacrifice
Employee gross salary £30,000 £28,418
Employee take-home pay £22,495.84 £22,860.27
Pension contribution £1,800 pa gross paid by the employee (including tax relief) £1,800 pa gross paid by the employer
Cost to the employer £32,948.78 £32,948.78

Example 2

This example ‘keeps the pension contribution constant’.

The employee sacrifices some of their gross salary so that, after sacrifice, the personal contribution is altered to an employer contribution of the same amount and the employee’s take-home pay is increased. Assume another employee is earning £60,000 pa (so is a higher rate taxpayer) and is contributing £300 per month as a personal contribution before salary sacrifice. Simply using salary sacrifice means they can increase their take-home pay by £325.46 each year whilst maintaining the same pension contribution, which switches to being paid by the employer after sacrifice. This is as a result of paying less tax and NI on the reduced salary after sacrifice of £56,837. There’s no additional cost to the employer who is passing on the full benefit of their (13.8%) NI saving to increase the employee’s take-home pay.

Example 2
  Before sacrifice After sacrifice
Employee gross salary £60,000 £56,837
Employee take-home pay £41,175.84 £41,501.30
Pension contribution £3,600 pa gross paid by the employee (including tax relief) £3,600 pa gross paid by the employer
Cost to the employer £67,088.78 £67,088.78

Example 3

This example ‘keeps the employee’s take-home pay constant’.

The employee sacrifices some of their gross salary so that, after sacrifice, the personal contribution is altered to an increased employer contribution and the employee’s take-home pay stays the same. Assume a 40-year-old employee is earning £30,000 pa (so is a basic rate taxpayer) and is contributing £150 per month as a personal contribution before salary sacrifice. Simply using salary sacrifice means they can increase the pension contribution being made by £50.85 per month whilst keeping their take-home pay the same. This is as a result of paying less tax and NI on the reduced salary after sacrifice of £27,882. There’s no additional cost to the employer who is passing on the full benefit of their (13.8%) NI saving to increase the overall pension contribution, which switches to all being paid by the employer after sacrifice.

Example 3
  Before sacrifice After sacrifice
Employee gross salary £30,000 £27,882
Employee take-home pay £22,495.84 £22,495.84
Pension contribution £1,800 pa gross paid by the employee (including tax relief) £2410.28 pa gross paid by the employer
Cost to the employer £32,948.78 £32,948.78

Example 4

This example ‘keeps the employee’s take-home pay constant’.

The employee sacrifices some of their gross salary so that, after sacrifice, the personal contribution is altered to an increased employer contribution and the employee’s take-home pay stays the same. Assume another employee earns £60,000 pa (so is a higher rate taxpayer) and is contributing £300 per month as a personal contribution before salary sacrifice. Simply using salary sacrifice means they can increase the pension contribution being made by £53.16 per month whilst keeping their take-home pay the same. This is as a result of paying less tax and NI on the reduced salary after sacrifice of £56,276. There’s no additional cost to the employer who is passing on the full benefit of their (13.8%) NI saving to increase the overall pension contribution, which switches to all being paid by the employer after sacrifice.

Example 4
  Before sacrifice After sacrifice
Employee gross salary £60,000 £56,276
Employee take-home pay £41,175.84 £41,175.84
Pension contribution £3,600 pa gross paid by the employee (including tax relief) £4,237.91 pa gross paid by the employer
Cost to the employer £67,088.78 £67,088.78

In each example, the cost to the employer of employing the employee remains the same before and after sacrifice.

Salary sacrifice can benefit some people and can also be a very useful financial planning tool.

For example, dropping someone’s salary can put them below an income tax threshold, reducing the amount they pay in tax. It could also move them under the £50,000 threshold for child benefit or the £100,000 threshold for retaining the income tax personal allowance.

However, a lower salary could impact the mortgage borrowing someone could secure, reduce death in service benefit entitlement and impact eligibility for State benefits.

Therefore, assessing a client’s individual circumstances and how a salary sacrifice arrangement would affect them is an essential part of the advice process.

The important point is that there’s a valuable discussion for both employers and employees to have about the benefits of using salary sacrifice for pension savings.