There are many incentives around to encourage us all to save for our retirement but one that gets regularly overlooked is salary sacrifice.
More beneficial than tax relief
Many people may feel uncomfortable at the mere mention of “sacrificing” some of their salary or bonuses but, if used correctly, it can be more beneficial than tax relief.
Salary sacrifice or salary exchange as it’s often referred to, has been around for many years. It’s a government approved initiative which takes advantage of savings in National Insurance (NI) to increase the amount going into your pension without any additional cost to you or your employer. So how does it work?
Normally you would make any personal contribution to your pension from your net pay (after tax and employee national insurance). That contribution would be paid net of 20% tax relief and, if you were a higher rate tax payer, an additional 20% relief could be claimed via your self-assessment tax return.
Your employer makes the pension contribution for you
With salary sacrifice you no longer make your own pension contribution. Instead you exchange some of your gross (pre-tax) salary or bonus and in return your employer pays that amount into the pension as a company contribution. As your employer is no longer paying you that amount of exchanged salary they don’t have to pay 13.8% employer National Insurance on it. The overall cost is the same to the company so many employers will agree to rebate some or all of their NI saving into your pension.
A 13.8% enhancement is not a bad start, but as the great Jimmy Cricket once said “there’s more….” One of the additional benefits of sacrificing some salary or bonus is that your tax and NI bill is also reduced. This allows you to exchange a larger amount than you would have originally paid into the pension but without any reduction in your take-home pay.
The following example for someone wanting to contribute £5,000 shows the benefit of using salary exchange.
|Before Exchange||After Exchange|
|Employee net premium||£4,000||Nil|
|Take home pay||£26,155||£26,155|
Without salary exchange someone earning £40,000 would pay £6,000 tax and £3,845 NI before they then made a contribution of £4,000 out of their remaining take-home pay. With 20% tax relief they would have £5,000 paid into their pension and have disposable income of £26,155.
A 33% enhancement at no cost to you
Using salary exchange they will give up £5,883 of their gross salary and with the 13.8% employer NI rebate, £6,694 will be paid into the pension. As their tax and national insurance has reduced (because of the reduced salary) the disposable income is still £26,155 however the amount credited to their pension is £1,696 (33%) higher.
So where’s the catch? In truth, providing that your employer is prepared to facilitate the exchange, then there are no real downsides. There is sometimes a concern that salary exchange will reduce the amount of mortgage you can obtain. In reality most mortgage companies base their lending decision on your ability to repay the mortgage (from your net pay) rather than a multiple of your gross earnings. As your take home pay remains unchanged most lenders will take a sensible view if the circumstances are explained correctly.
Employers are not obliged to offer salary or bonus sacrifice but it’s definitely worth having a conversation with yours.