A salary sacrifice is an agreement between you and your company in which you forego or “sacrifice” a portion of your pay in exchange for non-cash benefits. These can include items like daycare vouchers or a company car, but the most common sort includes your employer making supplementary pension payments. A salary sacrifice pension tax relief scheme is one of the most typical ways to improve your pension portfolio if you’re looking for ways to do so. Here’s how these plans work, as well as the benefits and drawbacks.
What is a salary sacrifice pension?
If you’re enrolled in a workplace pension, both you and your company will make monthly contributions. In the United Kingdom, your employer is required to contribute at least 3%, although they might choose to contribute more.
A salary sacrifice plan is one way to boost these payments. It means that your employer’s payments increase, but they’re truly your own contributions because your paycheck is proportionally lowered. The payments, however, are treated as employer contributions rather than employee contributions.
Your gross (pre-tax) compensation will be reduced as a result of this reduction, but there are benefits for both you and your company. You’ll pay less income tax and National Insurance (NI) on your earnings because your gross wages are now lower. In addition, your firm saves money on National Insurance.
Another advantage is that you determine how much salary to sacrifice. Your take-home pay will not be any lower than it would be if you made the pension contributions yourself as employee contributions.
How does a salary sacrifice pension scheme work?
How does salary sacrifice help you save for retirement? This is what happens as the procedure progresses.
Jane earns £35,000 each year and contributes 5% of her salary to her pension, while her employer contributes 3%. Jane contributes £1,750, while her company contributes £1,050, for a total contribution of £2,800.
She decides to forego a portion of her pay, bringing her total earnings to £32,941. Jane’s pension contributions remain at 5%, but the money she sacrificed is paid directly into her pension by her employer. Who may also add on the savings from lower employer National Insurance contributions (NICs), and Jane saves on NICs as well. This brings the total contribution to £3,392.94 – a £592.94 increase over Jane’s previous pension.
Jane’s annual take-home salary would remain the same, at £26,040, but her pension would get significantly more money each month.
How much salary should I sacrifice for my pension?
Your present contractual arrangement with your employer will determine how much of your pay you can forfeit. The number cannot, however, imply that your salary is below the minimum wage.
When determining the amount, you should exercise extreme caution because it has a number of implications for your future finances. Consider both your retirement and pre-retirement goals, such as purchasing a home at a lower salary, which can limit your mortgage alternatives. It may also have an impact on some of your other earnings-related benefits. Such as life insurance or income protection insurance provided by your employer. Because statutory maternity and paternity pay is on your earnings. A lower salary may affect the amount of statutory maternity and paternity pay you are entitled to.
It’s critical to comprehend all of the areas that your decision will influence. To what extent, so that you can determine whether the benefits exceed the disadvantages.
What are the advantages of a salary sacrifice pension?
#1. Grows your pension pot faster
Because your company pays a larger monthly contribution, sacrificing a percentage of your salary is one way to grow your pension account faster.
#2. Saves on income tax and NI contributions
Because you pay tax and NI based on what you earn, cutting your salary decreases your tax and NI contributions as well.
#3. Extra pension tax relief
Income tax and NI contributions are not the amounts you save on your paycheck. Because conventional pension tax relief just reimburses income tax and does not include NI, this saves you a little more.
What are the disadvantages of a salary sacrifice pension?
#1. It may lower your take-home pay
Depending on how much of your salary you give up. You may end up with less money in the bank each month. However, you can set it up so that it costs you no more than paying regular employee pension payments.
#2. Impacts how much you can borrow
Your salary is by credit issuers to determine how much you can borrow. For example, a smaller amount may have an impact on the type of mortgage you can acquire.
#3. Impacts other earnings-related benefits
As previously stated, decreased earnings can have an impact on the number of other benefits you receive. Such as life insurance or mandatory maternity pay.
Salary sacrifice and tax
You will pay less tax and national insurance on your gross earnings if you give up a portion of your salary through a salary sacrifice arrangement. Your company will save money because they will not have to pay Employers’ National Insurance Contributions on the portion of your wages that you sacrifice. They may pass on some or all of these savings to you.
Salary sacrifice pension tax relief
Usually, the personal contributions you make to your pension are eligible for tax relief from the government. The standard amount of tax relief is a 25% tax top-up for basic rate taxpayers, meaning that if you put £100 into your pension pot, HMRC effectively adds another £25. When you make personal contributions to your PensionBee pension, PensionBee will claim your tax top-up for you and add it to your pension pot automatically. If you are a higher-rate taxpayer, you will need to claim any additional tax relief yourself through your self-assessment tax return.
Pay sacrifice contributions are not eligible for tax relief because you will have already benefited from lower taxes on your lower salary. As a result, you won’t need to file a salary sacrifice tax return and won’t be eligible for tax relief.
Things to consider before taking a salary sacrifice
While there are some advantages to participating in a salary sacrifice program, there are also some drawbacks. If you agree to accept a lower income, your employer’s benefits may also be reduced. If you qualify for sick or holiday pay, for example, the amount you receive will be reduced. Also, if you plan to take a prolonged leave or claim maternity or paternity leave, you may not be able to earn as much as you require.
Just in case you choose to forego your pay and live on a lesser income for an extended period of time. It may impair your future eligibility for the State Pension. You must have paid National Insurance Contributions (or obtained applicable credits) for at least 10 years to be eligible for the new State Pension. You must have paid National Insurance Contributions for at least 35 years to obtain the full State Pension.
Is there a limit to a salary sacrifice pension Tax Relief scheme?
There is no upper limit to how much you can give up. Your lowered pay must, however, stay above the national minimum wage. You should also keep in mind that you are only to contribute a total of £40,000 to your pension funds each year. This includes employer payments, so be sure your greater salary sacrifice contributions don’t put you over the limit. It’s also a good idea to double-check your pension provider’s minimum and maximum contribution limits.
What’s the difference between auto-enrolment and a salary sacrifice pension Tax Relief scheme ?
Every business is by law to auto-enroll their employees in a workplace pension system if they are between the ages of 22 and state pension age and earn a minimum of £10,000 per year. These employees are in the plan by default, with the option to opt-out. Salary sacrifice pensions, on the other hand, are fully at the discretion of your employer, and you can choose whether or not to participate. It’s 100% optional, and you can unsubscribe at any time.
Is pension salary sacrifice the right retirement option
While salary sacrifice normally results in your employer making larger pension contributions. It is not for everyone, and we urge that you obtain independent financial advice to ensure that it is the right option for you.
The apparent disadvantage is that you’ll have less take-home money each month. So it might not be for you if you’re already struggling to meet your bills. Furthermore, if your salary is near to the federal minimum wage, you may not be eligible for salary sacrifice at all. As it is illegal for your company to pay you less.
You’ll also need to consider how the salary sacrifice tax relief scheme affects your lifetime pension contributions to the state pension. Which are calculated depending on your earnings over the course of your career.
FAQs
Does salary sacrifice reduce gross income?
Salary sacrifice is one of the simplest and most effective super-saving strategies. The value of this benefit is paid from your gross salary, i.e. before tax. This means that your gross salary is reduced by the cost of the benefit before the income tax is calculated.
Should I do salary sacrifice?
The main advantage of salary sacrifice can be higher take-home pay, as you’ll be paying lower National Insurance contributions (NICs). Your employer will also pay lower NICs. You might benefit from more pension contributions from your employer if they are giving you some or all the money they’re saving on NICs.
Can I use salary sacrifice to buy a car?
You save money as part of your salary is used to pay for the car every month, rather than paying large upfront costs. Therefore, it is one of the best options for having a new car for employees of companies that offer the salary sacrifice scheme.
