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.)
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.