Salary sacrifice: pension planning ideas

4 min read 5 Apr 22

By The Technical Team

Overview

There are a number of planning opportunities around Salary Sacrifice (or Exchange) which can produce the same pension contribution at a lower net cost, or a higher pension contribution at the same net cost.

Key points

Salary Sacrifice is an agreement between an employee and their employer. The employee agrees to exchange part of their gross (before tax) salary in return for a non-cash benefit, such as a pension contribution.
Reducing salary results in a saving in individual income tax and employee and employer national insurance contributions. As a result of the savings, when compared with the employee making personal pension contributions, salary sacrifice can produce the same pension contribution at a lower net cost, or a higher pension contribution at the same net cost.
One-off bonuses can be sacrificed in a similar way to salary.

What is salary sacrifice?

'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.

Rates bands and allowances

Case studies use UK rates and allowances for the current tax year. Employee National Insurance is using the “Effective Annual threshold” of £11,908, which refers to the Primary Threshold level if the weekly level was applied for a full year. This is based on the Primary Threshold being £9,880 from 6 April 2022 until 5 July 2022, and then £12,570 from 6 July 2022 until 5 April 2023.

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.

Maintaining pension contributions at lower cost

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

	Before	E'er Saving Passed On
Employee		0%	100%
Salary	£40,000	£37,600	£37,891
Less Income Tax	£5,486	£5,006	£5,064
Less National Insurance	£3,722	£3,404	£3,446
Less Contributions paid net*	£1,920	£0	£0
Take Home Pay	£28,872	£29,190	£29,399
Employer
Employer Pension Contribution	£0	£2,400	£2,400
Plus Salary Paid	£40,000	£37,600	£37,914
Plus employers National Insurance	£4,650	£4,289	£4,336
Cost to Employer	£44,650	£44,289	£44,650

*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 £318 and £528; and his employer can have no extra cost or save up to £361.

Maximising contributions at same cost

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.

	Before	E'er Saving Passed On
Employee		0%	100%
Salary	£40,000	£37,176	£37,176
Less Income Tax	£5,486	£4,921	£4,921
Less National Insurance	£3,722	£3,341	£3,341
Less Contributions paid net*	£1,920	£0	£0
Take Home Pay	£28,872	£28,872	£28,872
Employer
Employer Pension Contribution	£0	£2,876	£3,309
Plus Salary Paid	£40,000	£37,124	£37,124
Plus employers National Insurance	£4,650	£4,218	£4,218
Cost to Employer	£44,650	£44,218	£44,650

By swapping his personal provision for an employer contribution:

Roy can maintain his take home pay whilst increasing his pension contribution by between £476 and £909; and his employer can have no extra cost or save up to £432.

Bonus sacrifice

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.

Employee	Before Bonus	Bonus Taken	Bonus Sacrificed
Salary	£100,000	£115,000	£100,000
Less Income Tax	£27,432	£36,432	£27,432
Less National Insurance	£6,699	£7,187	£6,699
Take Home Pay	£65,869	£71,381	£65,869
Employer
Less Employer Pension Contribution	£0	£0	£17,258
Les Salary Paid	£100,000	£115,000	£100,000
Less employers National Insurance	£13,680	£15,938	£13,680
Cost to Employer	£113,680	£130,938	£113,680

Taking the £15,000 bonus would see take home pay rise by only £5,513.

Sacrificing the bonus has generated a £17,258 pension pot at no extra cost to the employer.

The 'perfect storm' of tax relief, NI relief and recovered personal allowance has meant sacrificing £5,513 of take home pay generates a £17,258 pension pot, or roughly 3 times the net amount given up.

Related insights

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