While auto-enrolment, which as of this month now covers all firms with at least 800 employees, looks to ensure that all employees have a pension scheme in place, only around two-thirds of members in defined contribution schemes with twelve members or more currently have a salary sacrifice scheme available to them.
The word ‘sacrifice’ by definition offers negative connotations and implies a need for someone to give up something important in order to gain other rewards. But in truth, salary sacrifice could be considered to be a sacrifice worth making.
The other term used for this process, salary exchange, is more accurate, as employees agree to give up part of their cash remuneration in return for some other non-cash benefit, such as a contribution to a pension plan.
The advantages of using salary sacrifice (or exchange), as a way of investing into an employer-based pension scheme, are
- Reduction in national insurance contributions. Assuming that the employee’s annual salary remains above the national insurance threshold of £7,755 pa, then there will be a minimum 2% reduction in the national insurance contributions payable by an employee and potentially up to 12% for those earning less than £41,450.
- Tax savings – by making contributions through salary sacrifice – if you are near to the threshold for the next tax level it can reduce your salary below the relevant threshold.
However, there are things to consider under the scheme, including:
- As your gross salary is lower, any life cover you may get from your employer could be lower as well, as this is often calculated as a multiple of salary.
- Other state benefits including redundancy pay, maternity pay and sickness benefits may be reduced by salary exchange – statutory maternity pay, for example, is based on an average of earnings and would therefore be affected if you chose to reduce your total wage.
- If you are looking to get a mortgage, your salary may be certified by your employer at your post-sacrifice level and this may affect your ability to raise the level of mortgage you require.
How salary sacrifice can work for an employee
For example, an employee currently earning £50,000 could elect to reduce their gross pay to £40,000, diverting £10,000 to their pension scheme. Through salary sacrifice, this would reduce the employee’s national insurance contributions by around £345 per year, from £4,215 to £3,870. Also, while salary sacrifice is broadly tax neutral, what it does allow is the employee to gain tax relief immediately rather than having to wait to regain through a combination of a self-assessment form and pension tax relief.
Furthermore, when compared to making the same pension contribution without using salary sacrifice, the savings made to the employee’s national insurance and the employer’s national insurance (where the employer agreed to redirect this to the pension as well) would in fact result not only in a potentially enhanced pension contribution, but an increased overall take home pay of £30,018 as opposed to £29,674 based on the standard income tax allowance.
Kate Turner, head of advice policy, Towry: “For any employee, provided they are making national insurance contributions, salary sacrifice – if offered by their workplace – could be a ‘win-win’ situation, and far more beneficial than a simpler method of placing contributions into a pension scheme.
“Employees should always seek advice as to the best options available to them for ensuring they have the biggest retirement fund they can achieve given their current financial circumstances.”
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