Salary sacrifice is an arrangement between an employer and employee whereby the employee agrees to forgo a portion of their salary in exchange for non-cash benefits. This arrangement is commonly used to optimise tax and National Insurance Contributions (NICs) for both the employer and employee. Salary sacrifice schemes are also referred to as Optional Remuneration Arrangements (ORAs).
While these arrangements offer tax and NIC savings, certain legislations exist to limit the extent of these benefits. Under these rules, employees are taxed on the higher of the amount sacrificed or the taxable benefit amount determined under the benefits rules.
However, some benefits are excluded from these regulations, meaning they remain unaffected by the tax and NIC rules. These include:
Provision of pension advice (qualifying for exemption)
Provision of cycles and cyclist safety equipment
Tax-free employer-provided childcare
Contributions to registered pension schemes
Cars with low CO2 emissions
In this article, we will explore how salary sacrifice can be used to make contributions to a registered pension scheme, and the associated benefits.
Salary Sacrifice for Pensions
Typically, when an employee contributes to a pension, PAYE is deducted after the contribution is made. However, employee NICs are still charged on the gross salary.
A salary sacrifice pension arrangement is a tax-efficient way to increase pension contributions, as it results in NIC savings for both the employer and the employee. Often, the employer's NIC savings are used to make additional contributions to the employee's pension, providing an extra boost to the pension fund.
To illustrate how salary sacrifice works in practice, let's consider the following example, comparing the outcomes with and without salary sacrifice.
Example
Mark earns an annual salary of £35,000 and contributes 5% of his salary to his employer’s pension plan, while his employer contributes 3%.
Without Salary Sacrifice:
Pension Position
Employer Pension Contribution: £1,050
Employee Pension Contribution: £1,750
Total Pension Contribution: £2,800
Take-home Pay
Annual Salary: £35,000
PAYE Tax: (£4,136)
Employee NIC: (£1,794)
Employee Pension Contribution: (£1,750)
Total Take-home Pay: £27,320
Cost to the Employer
Employer NIC: £3,574
With Salary Sacrifice:
Now, let's assume Mark enters into a salary sacrifice arrangement with his employer and sacrifices 5% of his salary in return for an increased employer pension contribution.
Pension Position
Employer Pension Contribution: £1,050
Salary Sacrificed: £1,750
Total Pension Contribution: £2,800
Take-home Pay:
Annual Salary (after sacrifice): £33,250
PAYE Tax: (£4,136)
Employee NIC: (£1,654)
Employee’s Pension Contribution: £0
Total Take-home Pay: £27,460
Cost to the Employer:
Employer NIC: £3,332
Summary
From the example, it’s clear that salary sacrifice allows the employee to maintain the same pension contributions while increasing their take-home pay, despite a reduction in gross income. This increase in take-home pay is primarily due to savings on the employee's NICs.
In the example above, Mark's take-home pay increased by £140, even though his gross salary was reduced by 5%. Additionally, the employer saves on NIC costs, as pension contributions made via salary sacrifice are exempt from NICs. The employer’s NIC costs were reduced by £242, which could also be contributed to Mark’s pension, further boosting the overall pension pot to £3,042.
Speak to an Expert
If you'd like more information on how salary sacrifice works and how both your business and employees can benefit from it, please don’t hesitate to contact our tax team. We’re happy to assist and provide further guidance.
Authored by: London Tax Team
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