Tag Archives: Employer contributions

Claire Trott, Financial Planning Week tip: The benefits of salary sacrifice

A reminder of the benefits of salary sacrifice


It has become common practice for employees to sacrifice part of their salary and/or bonus in return for their employer paying the amount sacrificed as an employer pension contribution on their behalf.

This can be far more attractive than the employee making a direct pension contribution, 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 their employer) will have paid NI contributions on the gross income received. This is not the case where the value of the contribution is sacrificed in exchange for their employer paying the equivalent as an employer contribution.

The employee will save the top part of their NI payment, which currently is 3.25%, or 13.25% depending on earnings. The employee pays the higher rate on monthly earnings between (currently) £1,048 and £4,189 and the lower rate over this on the rest of their earnings. So, this can be a significant saving and more for the lower paid than those earning over £4,189 per month. These rates are proposed to drop to 12% and 2% again on 6 November 2022, following the announcements on 23 September, which may feel that it is less good value. However, employees can only benefit from the savings they are making, they won’t be worse off.

In addition to personal savings, employers often pass on some or all of their savings. Employers currently pay 15.05% on all earnings paid above £758 per month. This doesn’t mean that they will pass on this whole amount. Often they give a set amount such as 10% or an amount based on their savings, such as 90% of their saving retaining the rest. The employer rate is also due to drop on 6 November, back to 13.8%, which may impact on the amounts passed on to members.

Whatever the rate and whatever is passed on from an employer, it is still better value than paying directly and, as every little helps, it makes sense to take advantage of this option if available.

(Note that, whilst NI for company directors is slightly different, for example they will generally pay a blended rate of NI taking into account the changes in rates throughout the tax year, the principles around making savings apply equally to directors and other employees.)

Additional benefits

For a taxpayer 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 be no effective delay in receiving higher or additional rate relief, because the salary is reduced before payment. By contrast if the contribution is paid directly by the employee to a personal pension scheme, higher or additional rate relief will need to be claimed via the employee’s self-assessment tax return. Of course, if the contribution can be paid to an occupational scheme of which the employee is a member, and which deducts member contributions using ‘net pay’, full tax relief will normally be available immediately.

All the usual benefits of pension contributions still apply, such as reducing income for tests such as the high-income child benefit charge. However, there are limits, such as  the salary should not be reduced below minimum wage and the agreement must be in place before the employee actually becomes entitled to the payment, so it isn’t possible to back date salary sacrifice payments.


If available, there isn’t any real downside to salary sacrifice if done correctly. It is important to ensure that when dealing with the paperwork it is a carefully constructed to ensure it qualifies for salary sacrifice but doesn’t impact on other benefits from the employer, such as death in service, bonus calculations and pay rises. Ideally, these should always refer to the pre-sacrifice salary. However, calculations such as mortgage multiples and other things that just consider gross salary could be impacted, because the pay slip will only show the reduced salary, and this would need to be considered before entering the arrangement. 

Chris Jones, Financial Planning Week tip: Making the most of pensions tax relief ahead of another Budget

As we approach another Budget there will no doubt be the usual speculation that pensions tax relief may come under attack. And with the latest HMRC statistics showing the estimated gross tax cost of pensions tax relief at £41.3bn in 2019/20, this may be too tempting for the Treasury to ignore.

Whilst wholesale changes to pension tax relief are unlikely in the short term, there may be some tinkering with allowances and reliefs. Any further changes are unlikely to make to make pension contributions more favourable. Therefore, where clients have the available funds and allowances, it may be better to make contributions sooner rather than later.

It’s worth a reminder of the limits and mechanics of the tax relief available on pension contributions to ensure clients can maximise the benefits of making any contributions.

Annual allowance

The annual allowance limits the tax benefits on the total contributions paid in a tax year. This will include contributions made by the individual, their employer, or a third party on behalf of the individual. The standard annual allowance is £40,000. High earners may have a lower tapered annual allowance, which can be as low as £4,000 and will depend on their level of earnings. Those who have accessed their pension benefits flexibly may be subject to the £4,000 money purchase annual allowance.

Where an individual exceeds their annual allowance in any tax year they are be able to carry forward any unused allowances from any of the three previous tax years.  

If, after allowing for any carry forward, the contributions exceed the individual’s annual allowance in any tax year, the individual will be subject to an annual allowance charge. The annual allowance charge aims to reclaim the tax relief received on the contribution. The excess over the annual allowance is added to the individual’s other taxable income and charged at their marginal rates of income tax. 

For example, if a higher rate taxpayer exceeds the annual allowance by £10,000 the annual allowance charge would be £4,000 assuming they remained within the higher rate band after adding the £10,000 to their other income.

Tax relief on personal contributions

Tax relievable personal contributions are limited to 100% of the individual’s relevant earnings in the tax year they are paid, which is broadly earnings from their employment or self-employment. Other types of income such as dividends or buy-to-let rental income do not count as relevant earnings. 

It is not possible to carry forward unused earnings from a previous year. If, for example, an individual has unused allowances of £90,000 and earnings of £30,000 the maximum tax relievable personal contribution is limited to £30,000.

Where an individual’s earnings are less than £3,600 they can pay and receive tax relief on contributions of up to £3,600 in any tax year. It is not possible to carry forward this allowance.

Tax relief is available on personal contributions at the individual’s highest marginal rates of tax. How the relief is applied depends on what type of scheme the contributions are paid into, either a “relief at source” scheme or “net pay scheme”. Aside from non-taxpayers (please see below), the tax relief available is the same whichever method is used.

Relief at source

Personal pensions and group personal pensions will operate as relief at source schemes. With these, the contributions are paid net of basic rate tax and the provider adds the tax relief. The provider then reclaims this directly from HMRC. Basic rate relief is added regardless of the tax rate the individual pays, even if they are non-taxpayer. Any higher rate or additional rate tax is reclaimed direct from HMRC by the individual. The relief is claimed by increasing the individual’s basic rate tax band by the gross value of the individual’s contribution.


Paul earns £70,000 a year and wants to make a gross contribution of £10,000 to a relief at source scheme. He pays a contribution of £8,000 to the pension provider who add the 20% tax relief.

Paul’s basic rate tax band is then extended by £10,000. This means that £10,000 more of his income is taxable at 20% rather than 40% and so he benefits from a further £2,000 of tax relief.

Net pay schemes

Most occupational schemes operate on a “net pay” basis. With this type of scheme, the individual’s pension contributions are deducted from their pay before it is subject to tax. This means the full amount of tax relief is applied immediately by reducing the taxable pay. Note though that National Insurance contributions are still applied to the full pay before the deduction of the pension contribution.


Fiona earns £80,000 a year. She pays personal contributions of £5,000 to her occupational pension scheme. The £5,000 is paid gross to the pension provider and her taxable income reduces to £75,000. The net cost to her of the £5,000 pension contribution is £3,000 so she has received 40% tax relief.

Note that because contributions simply reduce the level of taxable earnings, any non-taxpayer in a net pay scheme will not receive tax relief. This is an anomaly in the tax system and one the Government has been consulting on to resolve.

Salary sacrifice

With salary sacrifice, the employee reduces their salary in exchange for a pension contribution. Therefore, technically, the pension contribution is an employer contribution. For tax purposes it works in a similar way to a net pay scheme. However, the advantage of salary sacrifice is that it reduces the salary for all purposes, meaning that both the employer and employee also save the National Insurance on the amount sacrificed.

Tax relief on employer contributions

Employer contributions are always paid gross. As long as they are within the individual’s annual allowance there is no tax consequences on the employee. The employer can claim relief against corporation tax on the contributions as long as they meet what are known as the “wholly and exclusively” rules. Essentially this means that in order to benefit from tax relief, any contributions must be a genuine expense in the running of the business. In a normal employer/employee relationship this is unlikely to be an issue as there would usually be a genuine commercial reason for paying employer pension contributions as part of the employee’s reward structure.  

For small owner managed limited companies it can also be an extremely tax efficient way of extracting funds from the company. Again, meeting the “wholly and exclusively” condition in this type of situation is rarely a problem where the owner/director is taking on the business risks (e.g. as a shareholding director) of the company. However, issues can arise where contributions do not represent the fair market reward for a role – if, for example, a large contribution is made for the spouse of a director who has minimal duties (and that spouse is not is taking on the business risks of the company) and a pension contribution of that size would not normally be made for other employees who have similarly minimal duties.

Unlike personal contributions, employer contributions are not limited to the level of the individual’s earnings. So, for example, a director earning £10,000 could also receive an employer pension contribution of £40,000. The company will receive corporation tax relief on the contribution as long as it meets the “wholly and exclusively” rules.

Lifetime allowance

In addition to the limits on pension contributions, the lifetime allowance (LTA) sets a limit on the overall benefits that an individual can receive from all of their pension plans without suffering an additional tax charge. The LTA is currently £1,073,100 and is frozen at this level until 2025/26. Where an individual takes benefits in excess of this, or dies or reaches age 75 without taking their benefits, an LTA charge applies on the excess. The LTA charge is 55% if benefits are taken as a lump sum or 25% if the funds are used to provide an income. Any income is also subject to income tax at the point it is taken.

Where uncrystallised funds or funds in drawdown are subject to an LTA test at age 75 the tax charge on any excess is always at 25%.

With the LTA currently frozen, more and more clients are likely to be impacted by the limit and charges. This limit also needs to be considered for clients considering making further contributions.

Earlier in the year there were rumours that this limit may be reduced further, and this is one to watch out for in the Budget. The only positive news is that whenever the LTA has been reduced in the past, protection has been available to allow clients to protect the LTA at the current levels.