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Claire Trott: Is salary sacrifice losing its appeal?

Salary sacrifice arrangements could now have a knock-on effect on the annual allowance

Pension salary sacrifice used to be a no-brainer for most people. It meant a minimum personal National Insurance Contribution saving of 2 per cent – but, depending on earning levels, this could be 12 per cent. In many cases, the employer also offered some of its NIC savings as an additional pension contribution, so it was a win all around.

There are of course rules that need to be followed to ensure that it is a valid salary sacrifice, such as not reducing earnings below the minimum wage and ensuring that it is properly documented before the contribution is made. Care also needs to be taken when considering any salary-related benefits or possible borrowing multiples that may then be restricted.

Salary sacrifice still works for many but setting up a new salary sacrifice arrangement could now have a knock-on effect on the annual allowance.

Tapered annual allowance

The test to determine if the tapered AA should be applied is called the threshold income test. If threshold income is more than £110,000, then the adjusted income of the individual will need to be calculated and may reduce their AA to as low as £10,000.

When the tapered AA was introduced, the government included some clauses in the legislation to avoid individuals manipulating their income to remain below the threshold income in one year or multiple years.

Steve Webb: How cutting the annual allowance might end tapering

For some people, using salary sacrifice can mean it may be better to pay a personal contribution rather than sacrifice the income in favour of an employer contribution, even with the NIC savings. This is because the impact of exceeding the threshold income by even one pound could result in the loss of £30,000 of annual allowance. The loss of AA means a tax charge that will basically negate any tax relief given on their excess contribution.

The rules state any new or increased/amended pension salary sacrifice arrangements after 8 July 2015 will need to be added back into the threshold income calculation – whereas if the contribution were paid personally, it wouldn’t. This could mean that changing the way the contribution is paid could be the difference between being subject to the tapered AA or not.

Take an example of someone earning £120,000 gross and wanting to pay their bonus of £20,000 into their pension. Historically, they have salary sacrificed their bonus and their employer has been happy to facilitate this. However, this year the individual has had a significant pay rise as well as a larger-than-normal bonus tipping their basic pay over £100,000.

If this contribution is paid personally out of taxed income they will have a threshold income of £100,000 because the gross pension contribution will be deducted from the taxable income to get to the threshold income. This means they won’t be subject to the adjusted income test and will retain AA of £40,000.

However, if they sacrifice the whole bonus under salary sacrifice to pay the contribution, the deduction is effectively ignored, and they would therefore have a threshold income of £120,000 and be subject to the tapered annual allowance test.

Claire Trott: Contribution rise next step for workplace pensions

If these are their only contributions, this wouldn’t be an issue because their adjusted income would still be below £150,000, so there would be no impact on their AA. But should they have a large pension input amount from employer contributions or a defined benefit scheme then it could be the difference between an AA charge and no AA charge. The charge will be more than the NI saving because at this level, it will be 45 per cent for some or all of the AA excess.

There is an additional option for some – it should be possible to sacrifice some of their bonus to benefit from the national insurance savings but pay enough personally to bring them below the threshold income test. However, care will need to be taken to ensure that the salary sacrifice is documented appropriately.

The salary sacrifice anti-avoidance rules are designed to ensure individuals don’t manipulate their income to avoid the tapered AA. What they are doing is ensuring the individual and employer are still paying NICs they would otherwise have been avoiding.

For those that are not subject to the tapered AA, salary sacrifice still provides the same benefits all the time it is available. Pension salary sacrifice was protected when many other types of salary sacrifice were axed. So there may be a question over how long we have to consider this issue, as the government may well want to ensure that it is getting all the NI that it possibly can.

Claire Trott is head of pensions strategy at St James’s Place Group

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