Salary Sacrifice

If you make contributions to a personal pension, whether private (see Personal Pensions) or occupational (see Occupational Pensions), you may be able to have these contributions deducted automatically from your salary and sent to your pension scheme by your employer. Some employers will also offer you the chance of increased pension contributions if they begin paying your contributions directly. This is called 'salary sacrifice'.

Essentially, in a salary sacrifice scheme you sacrifice receiving a part of your salary in order to receive more pension contributions. For example, your employer may offer you a reduction in your annual salary of £2,000 in return for pension contributions of £2,250. Although you agree to a salary reduction, you may find that the tax advantages you receive when your employer pays your contributions mean that you actually have more take-home pay at the end of the year. When you pay pension contributions, you are entitled to income tax relief on that amount (see Tax Incentives for Saving). When your employer pays your pension contributions you pay no income tax on the contributions and they are not included when calculating your National Insurance contributions, because they are never a part of your salary.

For example: Natalie earns £34,000 a year. She currently pays £2,250 pension contributions annually. Her employer offers her a salary sacrifice scheme whereby they would pay £2,250 pension contributions on her behalf if she takes a salary cut of £2,000. Is this a good idea for Natalie?

Natalie would receive annual pension contributions of £2,250 at a cost of just £2,000 to her, from the salary sacrificed. Currently she pays less income tax because her pension contributions do not count as income. She pays more National Insurance contributions (see National Insurance Contributions) however, because she earns more money. If she were on the salary sacrifice scheme, she would pay slightly more income tax because she would not be entitled to tax relief on pension contributions, but lower national insurance contributions because she would earn less money. Her total take-home pay would actually increase by £415 if she took a salary reduction of £2,000, and she would continue to have £2,250 invested into her pension fund each year. Rather than lose money, Natalie would in fact have a better deal with the salary sacrifice scheme.

However, taking a cut in salary may affect the amount of State Second Pension (see State Second Pension) you are entitled to, since this is calculated according to your income. Make sure you assess the advantages and disadvantages before agreeing to change to a salary sacrifice scheme. Ask the pension scheme administrator or an independent financial advisor for assistance and advice based on your personal finances. For more information on calculating Income Tax, see State Pension Tax; for details on calculating your National Insurance contributions, see National Insurance Contribution Classes. For details of other ways to increase your pension see Increasing your pension.