Tag Archives: salary sacrifice

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. 

Retirement planning in 2022/23

As we welcome in a new tax year, here’s a look at pension planning for 2022/23.

Now that all the last-minute end of tax year pension planning is complete it is time to turn to 2022/23 and consider any changes that apply when advising on pension funding or taking benefits.

Although the pension tax regime has remained relatively stable over the last few years a new tax year always brings a few changes along with a fresh set of allowances to make the most of.

The main impact on pension funding is an indirect one – the increase in the National Insurance Contribution (NIC) rates and the accompanying increases in the dividend rates. Both these changes can make the advantages of pensions even greater in two key areas of pension planning:

Salary sacrifice and pensions

Employees can 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. Unlike salary/bonus, an employer pension contribution doesn’t attract NIC.

The 1.25% increases in employer and employee NICs makes salary sacrifice even more attractive. As well as the usual income tax relief, the additional benefit of salary sacrifice is the NICs savings for both employer and employee, made by reducing salary. Employers make their own decisions of how much of the NIC saving they pass onto their employees, with some passing all and some nothing at all. However, even if none, the employee will still benefit from their employee NICs savings.  

The benefits of salary sacrifice from 2022/23 onwards will be even greater. For employees, they will save an additional 1.25% on any of their earnings they choose to give up. Employers will save the same and may be willing to pass some or all of this onto the employee. This may lead to an increase in contributions via salary sacrifice and more employers wanting to set up salary sacrifice arrangements.   

The Government largely withdrew the income tax and NICs advantages where benefits in kind are provided through salary sacrifice arrangements (described in the legislation as ‘optional remuneration arrangements’) from 6 April 2017. However, pension contributions were exempted from that change.

The significant advantage may cause the Government to take another look at salary sacrifice arrangements, particular from next year where the tax becomes a separate charge, i.e. The Health and Social Levy. However, we are yet to see any signs of this, so it is unlikely that anything will change for this tax year at least.

Profit extraction from owner-managed limited companies           

For those in control of how they distribute funds from their company there are broadly there three main ways to extract the funds – either as salary, dividends or by making employer pension contributions. The increase in the NIC rates and dividend tax rates both make the extraction of profits via pension contributions more attractive. 

To provide a shareholding director with their immediate income needs, the company accountant will often suggest paying a minimal salary, perhaps up to the personal allowance (or in previous years the employer NICs secondary earnings limit) and the rest in dividends. As the rate payable on both the employer and employee NICs will have increased by 1.25%, this is unlikely to change, despite the increase in dividend tax rates. Therefore, advisers will usually be comparing paying further dividends with employer pension contributions at the director’s marginal rate of tax. 

Any further dividend payments will effectively result in additional corporation tax (because dividends are paid out of after tax profits) and the recipient will suffer higher dividend tax rates (assuming the tax free dividend allowance has already been used up) of 8.75%, 33.75% and 39.35%.

In contrast, a pension contribution can be made gross, and, providing it meets the usual “wholly and exclusively” rules, will be treated as a business expense. There will, of course, be tax when the pension is paid, but 25% of this is normally paid free of tax and the rest subject to income tax at the recipient’s marginal rates of income tax at the time.

Maximising allowances

Elsewhere, the main rates of tax relief on contributions, as well as the annual allowances, remain unchanged. For those unaffected by tapering or unrestricted by the money purchase annual allowance this is generally good news, with the £40,000 allowance providing adequate scope for most to make reasonable pension provision.

The personal allowance and the basic rate tax band remain unchanged at £12,570 and £37,700 so, for those in the decumulation phase, unfortunately, there is no scope to increase tax efficient income payments within these bands where they are already being fully utilised. However, for clients in the decumulation phase, the start of the tax year is a good time to review the most tax efficient way of taking money from their pension pots.

With the freezing of the tax bands and relatively high inflation it is likely that many more clients will fall into the “60% band” where income between £100,000 and £125,140 is subject to this very high marginal rate of tax. Pension contributions remain a very attractive option to reinstate the personal allowance and reclaim this tax. For someone earning £125,140 a pension contribution of £25,140 can be made at a net cost of just £10,056.

In terms of carry forward, the relevant carry forward years are now from 2019/20 and anything from previous tax years is no longer available. However, you can’t completely ignore prior years as they may be needed to offset any excesses in the three previous tax years. Remember, for the purposes of carry forward, the income in the previous tax years is only relevant where tapering applies. It is not possible to carry forward earnings.

In relation to tapering, we enter the third tax year with the higher Threshold and Adjusted Income limits of £200,000 and £240,000 respectively. Whilst this should mean far fewer clients are impacted, remember the lower limits of £110,000 and £150,000 still apply when calculating the availability of carry forward for tax year 2019/20 and any of the three earlier tax years where relevant.

Unfortunately, the Lifetime Allowance (LTA), which is frozen at £1,073,100 until the end of tax year 2025/26, remains one of the biggest challenges to retirement planning for affluent clients. For clients approaching or exceeding the LTA the benefits of continuing to fund are far less clear. The LTA can also prompt clients to take funds earlier from their pensions than they would otherwise. This is a particularly complex area of pensions planning and each client’s situation must be considered based on their specific circumstances. There are, though, many cases where funding in excess of the LTA can still provide an overall benefit and accepting the LTA can be a “least worst case” outcome.

The good news is that all the other benefits of pension planning remain in place and, importantly, there’s usually no need to wait until the end of the tax year. Now is a great time to start, or increase, a monthly pension contribution or make a one off lump sum to use up any remaining allowances.