Salary sacrifice: pension planning ideas

'Salary sacrifice' is the one term in the financial planning business that labours under a very unflattering and unfair terminology.

Moving salary to work harder and smarter for a client and / or their employer could be classed salary 're-worked' rather than salary sacrificed. This may be why it is now often called salary exchange.

Salary / Bonus are interchangeable.

There are three main strategies, the effectiveness of each depends on how much NI saving the employer is willing to pass on to the employee.

Details on salary sacrifice arrangements are covered in our Salary Sacrifice facts article.

Please note that any salary sacrifice arrangements which are made on or after 9 July 2015 (and whether before or after the start of the employment concerned), will be taken into account when calculating a client's threshold and adjusted incomes for the reduction in tax relief for higher earners which commenced in the 2016/17 tax year. 

Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. NSND income includes employment income, profits from self-employment (including sole trades and partnerships), rental profits, and pension income (including the state pension). Similarly, from 6 April 2019 Welsh Taxpayers pay the Welsh Rate of Income Tax (CRIT (C for Cymru)) on NSND income. 

Other tax and deductions such as Corporation Tax, dividends, savings income and National Insurance Contributions etc. will remain based on UK rules. This could mean the amount of income tax relief which can be claimed on pension contributions by Scottish and UK tax payers may not be the same. For more info on SRIT and how this works in practice, please visit our facts page. For more info on CRIT and how this works in practice, please visit our facts page.

Use our Salary Exchange calculator based on the relevant tax regime.

It’s also important to remember that for those with adjusted income over £360,000 that the minimum they will have for this year’s annual allowance will be £10,000.

At the end of the year Peter’s employer wishes to make a pension contribution for him of £7,500. Will this be a good idea for Peter?

No.

The new employer contribution is included in the taper calculation therefore this changes Peter’s adjusted income to £312,500. This then has a knock - on effect on his tapered AA, reducing this to £33,750. However, his total AA usage is now £37,500, so an excess of £3,750 exists. There is no carry forward available, therefore based on Peter’s tax rate this would result in a charge of £1,687.50.

Peter believes that this charge will be paid by his scheme as it fits the criteria for ‘mandatory scheme pays’ Is that correct?

No.

You can only call upon scheme pays if your tax charge is above £2,000 and your inputs to the scheme for the tax year are above the standard annual allowance. So mandatory scheme pays would not apply in Peter’s case.

Therefore Peter has had an extra £7,500 added to his pension, but this has cost him £1,687.50 from his own pocket. A cost of £1,687.50 to get £7,500 into a pension isn’t a bad rate of return, if we assume that he has to pay higher rate tax on the pension when he takes this extra £7,500 he will receive £5,250 (factoring in 25% tax free PCLS). Then the net benefit to Peter is £3,562.50.

But could there have been a better outcome for Peter?

Bob has a salary of £40,000 and is paying £2,400 gross per annum into his relief at source personal pension.

His employer agrees to make an employer contribution for him if he gives up some of his salary 

*The pension provider will add £480 basic rate relief and claim directly from HMRC.

By swapping his personal provision for an employer contribution:

Bob can maintain his gross contribution of £2,400 per annum and increase his take home pay by between £192 and £417; and his employer can have no extra cost or save up to £360.

From 6^th April 2029  Bob’s employee national insurance saving would reduce from £192 to £160 because £400 of his salary sacrifice contribution will be subject to national insurance, and his employer’s maximum national insurance saving would reduce from £360 to £300 because of the £2,000 cap on the national insurance exemption for salary sacrifice pension contributions.

Roy is paying £2,400 gross per annum into his relief at source personal pension.

His employer agrees to make an employer contribution for him if he gives up some of his salary. 

By swapping his personal provision for an employer contribution:

Roy can maintain his take home pay whilst increasing his pension contribution by between £267 and £667; and his employer can have no extra cost or save up to £400.

From 6^th April 2029 maintaining the same pension contribution would reduce Roy’s take home pay by £32 a year (£2.67 per month) and his employer would have no extra cost compared to the pre salary sacrifice position or save up to £300

One off bonuses can often move a member into a different tax or NI rate or cause the member to lose entitlement to personal allowances.

Bonuses can be sacrificed in a similar way to salary and significant amounts of 'relief' can be generated.

George earns £100,000 per year and he will become entitled to a £15,000 bonus in a few months. With earnings of this level George would lose £7,500 of his personal allowance. His employer has agreed to make the sacrifice arrangements and also to pass on all their NIC savings to George.

Taking the £15,000 bonus would see take home pay rise by only £5,700.

Sacrificing the bonus has generated a £17,250 pension pot at no extra cost to the employer.

The 'perfect storm' of tax relief, NI relief and recovered personal allowance has meant sacrificing £5,700 of take home pay generates a £17,250 pension pot, or roughly 3 times the net amount given up.

n.b. from 6^th April 2029 contributions made using bonus sacrifice will be included in the £2,000 cap on the salary sacrifice exemption for NI

Redundancy payments up to £30,000 are usually paid tax free. Any amount above £30,000 is subject to income tax and employer National Insurance, but not employee national insurance. It is often possible for an employee prior to receiving a redundancy payment to arrange with their employer to sacrifice part or all of their redundancy payment above £30,000 with  the value sacrificed being paid to their occupational pension scheme. Remember normal annual allowance limits apply to pension contributions made through redundancy sacrifice.

While sacrificing part of a redundancy lump sum will not save the employee any National Insurance it will mean that they only pay income tax on the part of their redundancy payment that they choose to receive with the rest moving seamlessly to their pension. If an employee waits to receive their full redundancy lump sum before making a personal pension contribution, the potentially significant income tax deduction from the taxable element may mean that they are not in a position to immediately make the pension contribution they intended.  If an employee remains unemployed for 4 weeks after being made redundant they can use a P50 to reclaim any overpaid tax: HMRC, Claim back tax when you have stopped working.