What is Salary Sacrifice?
Your company may offer Salary Sacrifice as a way of contributing to your pension scheme. Read more about the pros and cons and decide whether it is right for you here.
What is it?
Salary sacrifice is a tax efficient way of contributing to your pension. Unlike the standard contribution method where pension contributions are taken after tax, with salary sacrifice, you agree to a reduction in your base salary, and that reduction is paid directly into your pension.
For example, you’re earning £25,000 a year, and contributing the full amount for auto enrolment into your pension, which is 5% from 6 April 2019, with an employer contribution of 3%.
You agree to reduce your wages by 5% a year, which is £1250, or £104.17 a month. And your employer agrees to pay £1250 a year directly into your pension scheme instead, alongside their 3% contribution.
You may be thinking that that sounds exactly the same as paying 4% after tax and then getting the 20% tax back from the government afterwards to make it 5%. But you’d be wrong!
Advantages of Salary Sacrifice
The advantage of salary sacrifice is that alongside Income Tax, you also pay National Insurance contributions, which are dependent on the salary you earn. If you earn less salary, you pay less National Insurance, but you get the same amount of money into your pension.
Another advantage, if you’re lucky enough to be in the 40% or the 45% tax brackets, is that you’re effectively getting the full tax relief when the contributions are paid. You save paying that higher rate of tax, because you never got paid the money.
Disadvantages of Salary Sacrifice
There are some disadvantages to Salary Sacrifice, however.
Credit Applications
Since you earn less money, any calculations that take into account salary, such as credit applications for loans, mortgages and credit cards may take into account your salary post sacrifice. This may reduce the amount of money you are able to borrow.
Life Cover
Similarly, if your employer provides life cover that is worked out as a multiple of your salary, this could be affected.
No Refunds
Also, if you’ve paid any contributions using Salary Sacrifice, and decide to opt out, you won’t be able to receive a refund.
Benefit Entitlement
Reducing the amount of National Insurance you pay below a certain level may affect your entitlement to certain state benefits such as Statutory Maternity Pay and the State Pension.