Salary Sacrifice Pension Scheme

The salary sacrifice pension scheme has become increasingly popular in the UK as a way to boost pension savings while reducing both tax and National Insurance (NI) contributions. It’s a method where you, as an employee, agree to give up part of your gross salary in exchange for additional pension contributions from your employer. This guide explores how the salary sacrifice pension scheme works, its benefits and drawbacks, and whether it's right for you.

What is a Salary Sacrifice Pension Scheme?

A salary sacrifice pension scheme is an arrangement between an employee and employer. The employee agrees to reduce their salary in return for increased employer contributions to their pension. Since the employee’s salary is reduced, they pay less income tax and National Insurance, resulting in savings for both the employee and employer.

For example, if your salary is £30,000, and you agree to sacrifice £2,000 for your pension, your gross salary becomes £28,000. As a result, you pay less tax and NI contributions on this lower salary, and the £2,000 is added to your pension pot.

How it Work?

Here’s how salary sacrifice works in practice:

1. Agreement: You and your employer agree on how much salary you want to sacrifice.

2. Reduction in Gross Salary: The sacrificed amount is deducted from your gross salary (before tax is applied).

3. Employer Contribution: Your employer then contributes the sacrificed amount directly to your pension.

4. Tax Savings: Because your taxable income has decreased, you pay less income tax and National Insurance.

5. Employer Savings: Your employer also saves on their National Insurance contributions because your salary is reduced. Sometimes, employers pass these savings on to employees by contributing even more to their pension.

The Benefits of a Salary Sacrifice Pension Scheme

There are several advantages to using a salary sacrifice pension scheme:

1. Tax and National Insurance Savings

Salary sacrifice lowers your taxable income, which means you pay less income tax and National Insurance. This can result in considerable savings, particularly for higher earners.

• Income Tax Savings: By reducing your taxable income, you pay less tax. This can be especially beneficial for higher-rate taxpayers.

• National Insurance Savings: Since your salary is reduced, you also pay less in National Insurance. For basic rate taxpayers, this means saving 12%, and for higher-rate taxpayers, 2%.

2. Employer Contributions

In many cases, employers will pass on their National Insurance savings to the employee’s pension. For example, if your employer saves 13.8% in NI contributions on your sacrificed salary, they might add this amount to your pension pot, boosting your retirement savings.

3. Boosted Pension Pot

The salary you sacrifice is invested directly into your pension. Over time, this can significantly increase your pension pot, especially with compound interest and investment growth.

4. Potential for Lower Tax Bands

If your salary is just above a tax threshold (e.g., £50,270 for the higher rate), salary sacrifice can bring you into a lower tax band, reducing the rate at which you pay tax.

Disadvantages of a Salary Sacrifice Pension Scheme

While salary sacrifice pension schemes offer substantial benefits, there are a few drawbacks to consider:

1. Impact on Borrowing

Lenders assess your gross salary when deciding how much you can borrow for things like mortgages. A lower salary due to salary sacrifice could reduce the amount you can borrow, even though your take-home pay remains largely unaffected.

2. Impact on Benefits

Benefits such as statutory maternity pay, statutory sick pay, or even some redundancy payments are calculated based on your gross salary. Salary sacrifice reduces this figure, which could impact your entitlements.

3. Effect on State Pension

Salary sacrifice reduces your National Insurance contributions, and if your salary falls below the Lower Earnings Limit (£6,396 for 2023/24), you might not build up qualifying years for your State Pension. However, this is usually not a concern for most people unless their salary is very low.

4. Employer Limitations

Some employers may limit the amount of salary you can sacrifice, or they may not pass on all of their National Insurance savings. The availability and generosity of the scheme can vary from one employer to another.

How Much Can You Contribute via Salary Sacrifice?

The annual limit for pension contributions eligible for tax relief is currently £60,000 or 100% of your earnings, whichever is lower. This is known as the "Annual Allowance." However, if you earn more than £240,000, this limit is gradually reduced (tapered) to as low as £10,000 for very high earners.

It’s also important to note that your contributions, along with employer contributions and any tax relief, must not exceed this allowance. Otherwise, you could face a tax charge.

Salary Sacrifice and Pension Contributions: An Example

Let’s look at an example to understand how salary sacrifice can save you money:

• Employee Salary: £50,000

• Pension Contribution: 5% (£2,500)

• Salary Sacrifice Amount: £2,500

• New Taxable Salary: £47,500

• Income Tax Saving: £500 (40% on the £2,500)

• National Insurance Saving: £50 (2% on the £2,500)

The employee saves £550 in total. In addition, the employer saves 13.8% in National Insurance on the £2,500, amounting to £345, which may also be contributed to the employee’s pension pot.

How to Set Up a Salary Sacrifice Pension Scheme

For Employees

1. Speak to Your Employer: Find out if your employer offers a salary sacrifice scheme and how it works.

2. Decide on the Sacrifice Amount: Determine how much salary you can afford to sacrifice. This could be a percentage of your salary or a fixed amount.

3. Sign an Agreement: You’ll need to sign an agreement with your employer, formally agreeing to the reduction in salary and increased pension contributions.

For Employers

1. Consider Employee Communication: Explain the benefits and impact of salary sacrifice to employees. They need to understand the implications fully.

2. Set Up the Scheme: Work with payroll providers to implement salary sacrifice effectively, ensuring contributions are paid correctly into employees’ pensions.

3. Ensure Compliance: Keep in line with HMRC regulations to ensure tax and NI savings are legitimate and appropriately documented.

Can You Cancel a Salary Sacrifice Pension?

Salary sacrifice arrangements are flexible. If you find that the scheme is not working for you, or your circumstances change, you can stop or alter your sacrifice amount by contacting your employer. However, changes usually only take effect after a fixed period, such as the start of a new tax year.

Conclusion: Is Salary Sacrifice Pension Scheme Worth It?

The salary sacrifice pension scheme is a valuable option for many employees in the UK, offering significant tax savings and boosting pension contributions. However, its suitability depends on your financial situation, particularly regarding any benefits or loans you might need in the future.

Before making any decisions, it’s worth speaking to a financial adviser or consulting with your employer’s HR or payroll team to understand how salary sacrifice could work for you. For many, it’s an excellent way to save more for retirement while reducing their tax burden.