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   Salary sacrifice
  Salary Sacrifice   "increasing pension funding
with the same take home pay

An employee can increase the contributions to their pension by over 30% for a basic rate taxpayer and maintain the same take home pay. This is achieved where the reduction in tax and National Insurance received by the employer is invested directly into the employees money purchase pension.
  Introduction   Salary Sacrifice Scheme   Pension increases
  National Insurance   Employer salary costs   Income unchanged
  Savings gap   Lower scheme costs   Long term growth
  Net Pay Scheme   Change existing scheme   Other changes
  Scheme benefits    

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Salary sacrifice allows basic rate tax paying employees to increase pension payments by up to 31% at no financial cost. This increase is paid for purely by savings made in Income Tax and National Insurance. In November 2004 the Treasury gave a green light to salary sacrifice that will cost the Chancellor more than £1 billion a year in lost taxes.

A great number of employees in the UK, irrespective of their salary, can benefit from salary sacrifice. By making some simple adjustments to their salary the employee that contributes to a pension can take home the same income but see their pension contributions increase by 31%, this amount in addition to the tax advantages already given to pension arrangements. Only employees in a money purchase such as group personal or stakeholder pensions or employees with no pension arrangement are considered. However, it is possible for employees with a final salary pension to use Salary Sacrifice.

Salary Sacrifice Schemes are legal and allow employers to pay pension contributions on behalf of the employee in return for a reduction in salary. By doing this there is a saving in employee taxation and National Insurance contributions for both employee and employer. The lucrative benefits of salary sacrifice has resulted in a number of major companies adopting the schemes such as BT, LogicaCMG, Tesco and Sainsbury. They are likely to be followed by small to medium companies due to the low cost of implementation to the employer, up to 68% less than a traditional group personal or stakeholder pension where the total contribution to the scheme is 10% of payroll.

Example given: To explain how salary sacrifice works, the individual examples assume an employee on £24,000 salary contributing 5% net (£1,200 pa or £100 pm net) to a pension. However, salary sacrifice can apply to any employee on any salary.

National Insurance
In April 2002 the Chancellor announced a significant increase of National Insurance contributions for both employees and employers effective from 6 April 2003 as follows:

National Insurance rates
Year Employee Employer
2002/03 10% 11.8%
2003/04 11% 12.8%
2009/10 11% 12.8%

Although direct personal taxation and corporate tax has decreased since the 1980's, this has been offset by increases in Value Added Tax (VAT) and National Insurance (NI) contributions. It is unlikely that this approach will change in the foreseeable future and therefore both employee and employers can benefit from the use of tax mitigating schemes, such as salary sacrifice that particularly benefits from the mitigation of employers NI contributions.

Savings gap
The savings gap is the difference between the actual savings in the UK by individuals and the required estimated savings to provide a suitable retirement income. In the UK the savings gap is currently estimated to be £27 billion.

Traditionally pensions have been promoted as a very tax efficient savings vehicle. This has been in the of a Net Pay Scheme such as a personal pension or stakeholder pension, however to bridge the savings gap employees and employers must implement schemes that encourage greater savings.

A Salary Sacrifice Scheme is one option that goes some way to achieving this with minimal financial cost to both employee and employer.

Net Pay Scheme
Where an individual makes a personal contribution to a pension plan, the Government gives a tax incentive. This also includes a group personal pension or group stakeholder pension scheme and the following calculation shows how a £100 pm contribution (or £1,200 pa) is 'grossed up' and invested in the pension plan.

Pension paid by employee:

  £ £
Net pension   1,200
Add: 22% tax on gross 338  
Gross pension   1,538
Increase in pension   28.21%

This 'grossing up' means an extra 28.21% is invested in the plan immediately for every contribution made, or £128.21 pm rather than £100 pm.

This is how the Government encourages employees to invest in a pension for their retirement and is effectively a return of income tax foe all money invested in a pension plan.

Salary Sacrifice Scheme
As an alternative to the Net Pay Scheme, the employee can opt for a salary sacrifice scheme. Under this arrangement the employee opts to sacrifice part of their gross income for a corresponding pension contribution.

This pension contribution is treated as an employer's contribution by the Inland Revenue. In order to maintain the employees take home income, the amount of salary they must sacrifice would be £149 pm (or £1,791 pa) based on a basic rate tax salary of £24,000 pa as follows:

Pension paid by employer:

  £ £
Net pension 1,200  
add: NI employee savings 197  
add: Income tax savings 394  
Salary sacrifice   1,791
add: NI employer savings 229  
Gross pension   2,020
Increase in pension   68.35%

In the above example the employer invests in the employee's pension plan the salary sacrifice amount of £1,791 and the employer National Insurance savings of £229 making a gross pension contribution of £2,020 pa.

This results in an extra 68.35% being invested in the plan immediately for every contribution made, or £168.33 pm rather than £100 pm for a basic rate taxpayer. For a higher rate taxpayer the increase is 91.2%, or £191.20 pm rather than £100 pm.

This increase is 31.34% higher per contribution than a Net Pay Scheme and the employee's take home income remains unchanged.

Income unchanged
When an employee opts for a salary sacrifice scheme rather than a Net Pay Scheme they sacrifice part of their gross income for a corresponding pension contribution paid by the employer. This means that if employees are contributing to a pension, they will stop the contributions and the employer will pay them instead.

The following example is based on an employee contributing £100 pm (or £1,200 pa) net. The employee's gross income will reduce from £24,000 pa to £22,209 pa. Taxation is based on rates and allowances for the 2004/05 tax year.

National Insurance rates
  Current Scheme (£) Salary Sacrifice (£)
24,000 22,209
  Income tax
3,994 3,600
2,188 1,991
  Net pension
1,200 0
16,618 16,618
Example - Assumes an employee is on a salary of £24,000 paying £120 pm net (or £1,200 pa) and sacrifice £1,791 pa salary. The employer is responsible for the pension payment of £2,020 pa gross.

There is no change in take home income because although under the Salary Sacrifice Scheme gross salary has reduced so has income tax, NI contributions and the responsibility for pension payments is now the employers. Net income is the same at £16,618 per annum even though gross income has been reduced by £1,791 per annum.

Pension increase
In a traditional Net Pay Scheme the employee pays their pension contributions out of their net pay and this is 'grossed up' when invested into the pension plan. The employer may also choose to contribute. However, in a Salary Sacrifice Scheme the employer pays into the employees pension plan as follows.

Who pays what and from where
  Current Scheme Salary Sacrifice
  Paid by
employee employer
  Net pension (£)
1,200 0
  Salary sacrifice (£)
0 1,791
  NI savings (£)
0 229
  22% tax on gross
338 0
  Gross pension (£)
1,538 2,020
Example - Assumes an employee is on a salary of £24,000 paying 5% of salary into a pension. Take home pay for both current and Salary Sacrifice Scheme is £16,918 per annum.

In a Salary Sacrifice Scheme the employer invests the salary sacrificed by the employee, £1,791 pa and also the employer NI savings of £229 pa. The employer's NI is saved because the employer pays a smaller gross salary to the employee, £22,209 instead of £24,000 in this example.

This means the gross pension increases from £1,538 per annum in a Net Pay Scheme to £2,020 per annum for the Salary Sacrifice Scheme, an increase of 31.34% for every contribution made.

Long term growth
Salary Sacrifice Schemes benefit significantly from the extra 68.35% increase in pension contribution paid by the employer for basic rate taxpayers and 91.2% for higher rate taxpayers.

This compares to a Net Pay Scheme where the extra increase is 28.21% for a basic rate taxpayer and 66.67% for a higher rate taxpayer.

Saving £100 pm for 10 years
Investment Fund Value (£)
  Salary Sacrifice Scheme
  Pension (Net Pay Scheme)
  Cash ISA
  Bank account
Assumes 7% growth per annum for pension and Salary Sacrifice Scheme and 1% charges. Assumes charges for Cash ISA and bank account is 0% and growth rate of 4% per annum.

The above schemes are not directly comparable as the cash based plans can be accessed 100% as tax free cash whereas the pension based plans are restricted to 25% tax free cash with an income paid for the balance. At retirement the employee can use the much greater pension fund to purchase an annuity, before making a decision regarding a pension income, learn more about annuities, compare annuity rates and secure a personalised annuity quote offering guaranteed rates.

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