Last year’s summer Budget raised a warning in respect of the use of salary sacrifice in exchange for additional pension provision. It stated:
“Salary sacrifice arrangements can allow some employees and employers to reduce the income tax and National Insurance they pay on remuneration. They are becoming increasingly popular and the cost to the taxpayer is rising. The Government will actively monitor the growth of these schemes.”
The Treasury emphasised this point in March’s Budget, adding:
“The Government’s intention is that pension saving, childcare and health-related benefits, such as cycle to work, should continue to benefit from income tax and NICs relief when provided through salary sacrifice arrangements.”
Clearly, salary sacrifice is an attractive method of boosting net income. For example, an employee approaching retirement, whose taxable earnings are £100,000 and who is scheduled to get a £10,000 bonus, might wish to consider sacrificing the bonus in lieu of an employer pension contribution.
If taken as pure remuneration, the earnings would creep into the band where tax allowances are lost. An individual in these circumstances effectively suffers tax on income within this band at 60 per cent, while also being subject to an employee NI payment of 2 per cent. The individual is therefore left with net remuneration of £3,800. Aside and not affecting the individual, the employer would suffer employer’s NI at the rate of 13.8 per cent.
By properly documenting the sacrifice of the full £10,000 bonus the employee could be significantly better off. The £10,000 contribution is paid directly to the chosen pension scheme, meaning it escapes the individual’s income tax regime. No employee’s NI is payable. The employer may also contribute the employer’s NI that would otherwise have been paid away, meaning a total contribution of £11,380.
Assuming the monies receive no growth within the pension fund and the individual subsequently draws this sum as a retirement benefit, a pension commencement lump sum of £ 2,845 would be receivable. The remaining sum of £8,535, when taken as either an uncrystallised funds pension lump sum or flexi-access drawdown payment, even if taxed at 40 per cent, would result in a net pension payment of £5,121, meaning total income received of £7,966 – over double that received from the direct remuneration route.
Sacrifice still works at lower levels of remuneration as, even though the income tax rates may be lower, higher employee NI rates might be applicable until the maximum thresholds are exceeded.
In circumstances where the individual might have reason to believe their health may result in death pre-age 75, salary sacrifice might also be useful. Taking the figures above, the remunerated £3,800 would potentially sit within the individual’s estate and be subject to inheritance tax, whereas the gross value of £11,380, if within lifetime allowance limits, would be payable outside of the estate without tax deduction whatsoever.
Martin Tilley is director of technical services at Dentons Pension Management