11th November 2013
Thousands of employees across the UK could be boosting their pension contributions and their take home pay by taking advantage of so-called salary-sacrifice but is it right for you?
While the Government’s auto-enrolment pension initiative looks to ensure that all employees have a retirement plan in place, only around two-thirds of members in these schemes with twelve members or more currently have a salary sacrifice, sometimes referred to salary exchange scheme available to them.
But for any employee, provided they are making national insurance contributions, salary sacrifice – if offered by their workplace – could be a ‘win-win’ situation, and far more beneficial than a simpler method of placing contributions into a pension scheme says Kate Turner, head of advice policy at financial adviser, Towry .
Essentially salary sacrifice, is when a worker agrees to give up part of their remuneration in a bid to receive tax or National Insurance savings for both themselves and their employer and in turn increase the value of their overall pay package.
Why use salary sacrifice?
Turner asserts that the primary advantage of salary sacrifice as a way of investing into an employer-based pension scheme, is that assuming that the employee’s annual salary remains above the national insurance threshold of £7,755 per annum, then there will be a minimum 2% reduction in the national insurance contributions payable by an employee and potentially up to 12% for those earning less than £41,450. She adds: “In addition, by making contributions through salary sacrifice – if you are near to the threshold for the next tax level it can reduce your salary below the relevant threshold.”
How does it work?
A worker earning £50,000 could elect to reduce their gross pay to £40,000, diverting £10,000 to their pension scheme. Through salary sacrifice, this would reduce the employee’s national insurance contributions by around £345 per year, from £4,215 to £3,870. Also, while salary sacrifice is broadly tax neutral, what it does allow is the employee to gain tax relief immediately rather than having to wait to regain through a combination of a self-assessment form and pension tax relief.
Turner says: “Furthermore, when compared to making the same pension contribution without using salary sacrifice, the savings made to the employee’s national insurance and the employer’s national insurance, where the employer agreed to redirect this to the pension as well, would in fact result not only in a potentially enhanced pension contribution but an increased overall take home pay of £30,018 as opposed to £29,674 based on the standard income tax allowance.”
Issues to consider
However, there are factors to take into account before making a decision – and professionl advice is highly recommended before making any decisions. One issue which needs consideration is that given your gross salary will be lower, any life cover you may get from your employer could be lower as well, as this is often calculated as a multiple of salary.
Other state benefits including redundancy pay, maternity pay and sickness benefits may be reduced by salary exchange. Statutory maternity pay, for example, is based on an average of earnings and would therefore be affected if you chose to reduce your total wage. In addition, if you are looking to get a mortgage, your salary may be certified by your employer at your post-sacrifice level and this may affect your ability to raise the level of mortgage you require.