Salary sacrifice (sometimes known as ‘salary waiver’) in the context of retirement planning is a contractual arrangement whereby an employee gives up the right to receive part of their cash remuneration, usually in return for their employer’s agreement to provide some form of non-cash benefit. Salary sacrifice is a voluntary scheme so, even if your employer offers it, they cannot force you to take part.
Many companies, with pension deficits, have used salary sacrifice as a way of cutting the cost of pensions by removing contributions from the National Insurance Contributions (NICs) net and hence saving money for both the employer and employee. It can effectively ‘increase’ up take-home pay at a time when staff are seeing wages squeezed because of higher pension bills.
Increased pension scheme contributions
Salary Sacrifice is offered by some employers as a means for their employees to receive increased pension scheme contributions. It is not an effective way of saving for everyone so, if your employer offers salary sacrifice, you should make sure you benefit before signing up. Salary sacrifice is about varying the employee’s terms and conditions as they relate to remuneration, and is a matter for agreement between the employer and employee.
Free of tax and NICs
To be effective, a salary sacrifice must be ‘given up’ before it’s subjected to tax or NICs. This allows the employee to save the entire amount of their sacrificed income in their pension plan free of tax and NICs.
You sacrifice part of your salary. The amount you sacrifice is paid to your pension plan directly by your employer, rather than being paid to you. As a result of you having a lower salary, both you and your employer pay less National Insurance Contribution (NIC). As part of the salary sacrifice deal, your employer pays all or part of their NIC saving to your pension plan along with the sacrificed amount.
For example, you earn £30,000 a year and decide you want to salary sacrifice £1,000. Your new salary is £29,000, with the employer paying £1,000 to your pension plan. You pay less NIC (and in some cases Income Tax) because your salary is lower. Your employer also pays less NICs and pays a percentage of their saving to your pension scheme.
The percentage of NIC saving your employer pays is defined by them as part of their salary sacrifice offer. It could be anything between 0 per cent and 100 per cent.
Salary sacrifice advantages
The main advantages are:
you pay less NIC (and in some cases Income Tax) because your income is lower; and;
you may receive a boost to your retirement savings because your employer may add a percentage of their NIC saving to your pension contribution.
Salary sacrifice disadvantages
Salary sacrifice results in you having a lower salary. This could affect the following:
life cover – your employer may provide you with life cover, which is usually calculated as a multiple of your salary. As your salary is lower under salary sacrifice, so may your life cover. Some employers may continue to provide life cover at the pre-salary sacrifice pay;
refund of contributions – some occupational pension schemes offer a refund of employee contributions on leaving with less than two years service. The contribution paid as part of the salary sacrifice arrangement is not an employee contribution so would not be refunded;
mortgage borrowing – mortgage lenders usually calculate the maximum borrowing level as a multiple of salary. As your salary is lower under salary sacrifice, your mortgage borrowing may be affected;
Statutory Maternity Pay (SMP) – SMP is available if you earn above the Lower Earnings Limit prior to going on
maternity leave. If salary sacrifice brings your salary below this level, your entitlement to SMP may be lost;
State Second Pension (S2P) – this additional part of the state pension is calculated with reference to your earnings. Any reduction in your earnings between the Low Earnings Threshold (£14,400 in 2011/12) and the Upper Accrual Point (£40,040 in 2011/12) may affect this entitlement;
State Second Pension (S2P) – as with SMP, if salary sacrifice brings your salary below the Low Earnings Threshold, your entitlement to S2P may be lost.
