Salary sacrifice is a tax-efficient way to contribute to your pension and significantly boost your retirement fund. Our latest article explains how a pension salary sacrifice works and the benefits of using salary sacrifice for contractors.
What is pension salary sacrifice?
Your umbrella company may offer a pension salary sacrifice service, which makes pension saving more tax-efficient and is a great way to boost your personal pension pot significantly. If you choose to use the service, you can allocate a percentage or set amount of your pre-tax salary towards your pension. You can receive tax relief and save up to £60,000 per tax year or up to 100% of your annual earnings – whichever is lower. You may also be able to carry forward unused allowance from previous years.
What are the benefits of pension salary sacrifice?
There are many benefits to using a salary sacrifice service:
- Everyone pays less tax – As the employee sacrifices part of their salary, the employer (umbrella company) and the employee (the contractor) pay less in National Insurance Contributions. The employee also pays less Income Tax.
- Increased take-home pay – Depending on the salary you choose to sacrifice and the tax due on your remaining wage, you may increase your take-home pay.
- Grow your pension fund faster – Sacrificing part of your salary for a higher pension contribution each week/month will allow you to grow your pension pot much quicker.
- Extra pension tax relief – Salary sacrifice contributions are not subject to Income Tax or National Insurance Contributions. This provides better tax savings as you’ll only receive tax relief at the highest rate of Income Tax that you pay on workplace pension contributions.
Are there any disadvantages of using a pension salary sacrifice?
Salary sacrifice isn’t for everyone, and it’s important to consider the points below before entering into a pension salary sacrifice arrangement:
- Lower take-home pay – Depending on how much salary you sacrifice, you might receive a lower take-home pay each week/month. However, you can choose to sacrifice only an amount that is no more than making employee workplace pension contributions.
- Lower life cover and borrowing power – As a result of your lower take home, you may receive lower life cover and lower borrowing options on mortgages and loans. Most providers will consider salary sacrifice, so checking before choosing a provider is essential.
- Not a viable option for everyone – Employers cannot offer salary sacrifice to employees if it reduces their salary to below the National Minimum Wage.
- Entitlement to state benefits may be affected – Entitlement to state benefits such as State Pension or Maternity Pay may be affected as the amount of National Insurance you pay is reduced.
Is pension salary sacrifice more beneficial than workplace pension contributions?
Workplace pension schemes
It is a legal requirement that every employer in the UK offers and enrols their employees into a workplace pension scheme, provided that those employees are between the age of 22 and state pension age and earn at least £10,000 annually. You can opt out if you do not want to use the workplace pension scheme. If you choose to contribute to the workplace pension scheme, the minimum contribution set by the government that you and your employer can pay into the pension is 8% – this is usually split into 5% employee and 3% employer.
One of the benefits of saving into a workplace pension is the government boosts your pension contributions through tax relief. The tax relief you receive will depend on your income tax rate. However, most UK taxpayers will get a 20% top-up from the government on their pension payments. You also benefit from a tax-free pension allowance, which is the total amount that can be paid into your pension plan before a tax charge applies – this is £60,000 for the 2023/24 tax year. Once the new tax year commences, your annual allowance will renew.
Salary sacrifice
Salary sacrifice is not a requirement, and it is entirely at your employer’s discretion to offer the service to employees. It’s completely voluntary, and you can opt in or out anytime. Contributing more to your pension via salary sacrifice is a great way to be more tax-efficient. Salary sacrifice pension contributions are taken from your salary before tax is deducted, reducing your taxable income.
If you are a basic rate taxpayer, you’ll automatically get 20% tax relief on your contribution. If you’re a higher or additional rate taxpayer, you can claim additional tax relief by completing a self-assessment tax return. The increased salary sacrifice pension contribution reduces your salary, meaning both you and your employer will pay lower National Insurance Contributions, and you will also see a decrease in your income tax due on your remaining salary.
How do salary sacrifice contributions differ from workplace pension contributions?
The example below explains how salary sacrifice pension contributions can boost your pension pot compared to contributing to your pension through a workplace pension scheme.
Rachel has an annual salary of £35,000 and contributes 5% to her pension, and her employer contributes 3% through a workplace pension scheme. This means that Rachel is contributing £1,750, and her employer is contributing £1,050 – a combined total contribution of £2,800.
Rachel decides to use salary sacrifice and sacrifice some of her salary, reducing her gross salary to £32,941. Her pension contributions are still 5%, but her employer pays the sacrificed money directly into her pension. Through salary sacrifice, Rachel’s pension is receiving a total contribution of £3,392.94, which is £592.94 more than would have been contributed through a workplace pension scheme.
Salary sacrifice is an excellent way to save tax-efficiently for your retirement as not only will this help grow your pension pot quickly, but contributions will also be exempt from tax and National Insurance.
How to decide how much of your salary to sacrifice
There isn’t a specific limit to how much of your salary you can sacrifice. However, your reduced salary has to remain above the National Minimum Wage. It is also essential to remember that you can only contribute a total of up to £60,000 or 100% of your annual income, depending on whichever is lower and tax-free, and after this threshold, a tax charge will apply. This includes employer contributions, so ensure the higher contributions from your salary sacrifice don’t push you over this threshold. Depending on your pension provider, there may be minimum and maximum contribution limits, and it’s helpful to check and ensure your contributions are within the limits.
Does salary sacrifice affect state pensions?
It is important to consider your pre-retirement goals when deciding how much of your salary to sacrifice, as it can affect your entitlement to contribution-based benefits such as state pension. Your state pension is based on your National Insurance Contributions, and as salary sacrifice reduces the earnings on which National Insurance is due, this may impact your state pension. Salary sacrifice can also affect your entitlement to earning-related benefits such as Maternity/Paternity Pay or life cover. Before entering into a salary sacrifice arrangement, you must understand all the areas your decision will affect and whether the positives outweigh the drawbacks.
Contact us to find out more about our Salary Sacrifice Service
Churchill Knight Umbrella is delighted to offer a salary sacrifice service to help you save more tax-efficiently for retirement. Whether you’re an existing Churchill Knight Umbrella employee or new to contracting, we can get you set up quickly if you’re interested in salary sacrifice. To learn more about our service or request a free take-home pay illustration, please call us on 01707 871622.
