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Pensions

Salary sacrifice: pension planning ideas

Last Updated: 6 Apr 24 4 min read

Contents

1. Overview

2. Key Points

3. What is salary sacrifice?

4. Rates bands and allowances

5. Maintaining pension contributions at lower cost

6. Maximising contributions at same cost

7. Bonus sacrifice

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.

Further to this in the Mini Budget / Growth Statement on 23 September 2022 National Insurance rates from 6 November 2022 will drop by 1.25%. Giving an “effective annual rate of NI of 12.73% between the Primary Threshold and Upper Earnings limit and 2.73% for earnings above the Upper Earnings Limit. This also gave an effective annual rate of NI of 14.53% for employers. 

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 £2,194 £2,002 £2,026

Less Contributions paid net*

 £1,920 £0 £0
Take Home Pay £30,400  £30,592 £30,801
Employer      
Employer Pension Contribution £0 £2,400 £2,400
Plus Salary Paid £40,000 £37,600 £37,891
Plus employers National Insurance £4,264 £3,933 £3,973
Cost to Employer £44,264
 £43,933 £44,264

*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 £402; and his employer can have no extra cost or save up to £331.

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 £37,333 £37,333
Less Income Tax £5,486 £4,921 £4,921
Less National Insurance £2,194 £1,981 £1,981

Less Contributions paid net*

 £1,920 £0 £0
Take Home Pay £30,400  £30,400 £30,400
Employer      
Employer Pension Contribution £0 £2,667 £3,035
Plus Salary Paid £40,000 £37,333 £37,333
Plus employers National Insurance £4,264 £3,896 £3,896
Cost to Employer £44,264 £43,896 £44,264

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 £635; and his employer can have no extra cost or save up to £368.

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 £4,011 £4,311 £4,011
Take Home Pay £68,557 £74,257 £68,577
Employer      
Less Employer Pension Contribution £0 £0 £17,070
Les Salary Paid £100,000 £115,000 £100,000
Less employers National Insurance £12,544 £14,614 £12,544
Cost to Employer £112,544 £129,614 £129,614

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

Sacrificing the bonus has generated a £17,070 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 £17,070 pension pot, or roughly 3 times the net amount given up.

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