Tag Archives: Pensions

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

A reminder of the benefits of salary sacrifice

Introduction

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.

Comments

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: Pensions tax relief where clients have dividend or investment income

A reminder of how higher rate tax relief is applied and how, in some cases, the total tax relief can be more than 40%

Tax relief on personal pension contributions is limited to a maximum of 100% of the individual’s relevant UK earnings in the tax year the contributions are paid (and a minimum of £3,600). Essentially, this means the money the client has earned from their employment or the taxable profits from their self-employment.

Key investment income sources such as rental profits (other than those from qualifying furnished holiday lets), dividend income or savings income are excluded. However, this doesn’t mean that higher rate tax relief is not available on these types of income. This is because of the way in which the tax relief is applied.

With a relief at source scheme, the contribution is paid net and the provider will add the basic rate tax relief and reclaim this from HMRC. The individual’s basic rate tax band is then extended by the gross value of the pension contribution. This means the income that would otherwise fall into the higher rate tax band may now fall into the basic rate tax band. It doesn’t matter what form of income that is, i.e. the tax relief can be obtained against earned income, rental profits, savings income or dividend income. Where it is the latter, the rate of tax relief is higher than 40%.

Example

A client has £12,000 of earnings and also receives £60,000 of dividend income. The maximum tax relievable personal contribution they could make is limited to £12,000 in the tax year. They pay the pension provider £9,600 net and the provider adds the £2,400 of tax relief.

The client’s basic rate tax band is then extended by £12,000 from £37,700 to £49,700. This means that £12,000 more of the dividend income is now taxed at the basic dividend rate of 8.75%, rather than the higher rate of 33.75% – a 25% saving or £3,000. This means the total tax relief is 45% (£2,400 + £3,000 = £5,400. £5,400/£12,000 = 45%).

Where individuals make contributions to a net pay scheme, i.e. an occupational scheme, the rate of tax relief is, currently*, exactly the same (aside from the anomaly for those with total taxable income below the personal allowance) as the taxable income is reduced by the gross contribution.

Note that although the dividend tax rates are reducing from tax year 2023/24, the tax saving in this example will still be the same as the rate will reduce down from 32.5% to 7.5%, i.e. 25%. And, although the basic rate of income tax is set to reduce to 19% from 6 April 2023, there will be a one-year transitional period for Relief at Source (RAS) pension schemes to permit them to continue to claim tax relief at 20%. Individuals can only receive higher rate tax relief to the extent they would otherwise have paid higher rate tax if they hadn’t made the pension contribution. For example, someone with taxable income of £60,270 and a full personal allowance, could only benefit from higher rate tax relief on contributions of up to £10,000. Any further contributions would only benefit from basic rate tax relief. (£60,270 – £37,700 basic rate tax band – £12,570 personal allowance = £10,000 in the higher rate tax band.)

It is also important that higher rate tax payers in relief at source schemes ensure they make a claim for the higher rate tax relief they are entitled to either on their self-assessment tax return, or if they do not fill in a self-assessment tax return, they can call or write to HMRC to claim.

*The basic rate of income tax is set to reduce to 19% from 6 April 2023. Where individuals make contributions to a net pay scheme, i.e. an occupational scheme, from 6 April 2023, the rate of basic rate relief they will receive will be at 19%.

Budget 2021: Pensions

An overview of the pensions announcements in the 2021 Budget.

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Pension Death Benefits

Exploring the different options on death and the tax implications

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Pre Commencement Pensions

This video blog serves as a reminder of the impact that pre commencement pensions have on the lifetime allowance and when they need to be taken into account.

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Taxation of Pensions Income

This video blog looks at the how flexible pension income is taxed and how you can reclaim tax back from HMRC.

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Pensions Update: Changes on the horizon that are unlikely to be affected by the Budget

The increase to the Lifetime Allowance is set is stone in the form of the Finance Act 2016. What does an increase mean?

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Pensions update: Potential amendments to pensions to be made in the Budget

Reflections on potential Budget changes to pensions.

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Pension Transfers and IHT

The Staveley case and what it might mean for pension transfers by individuals in ill-health.

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The Future of Pensions Tax Relief

Change seems inevitable, the direction of travel seems clear – what can we expect when we get more detail at the next Budget?

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