Salary sacrifice - reprieved
Philip Hammond is, so far, appearing to be an unshowy chancellor. No rabbits pulled from hats, no flashy but unworkable proposals. Perhaps his civil servants at the Treasury have enough on their hands with Brexit to stop them thinking up new ways of tinkering with our already over-complicated tax system.
In a low-key autumn statement, one of the biggest changes was his alterations to the regime for salary sacrifice, tightening up a tax-reducing arrangement that had got out of hand, while keeping the parts that are in line with public policy.
Salary sacrifice – saving National Insurance payments and tax
Salary sacrifice arrangements have been around for some time. In essence, an employee gives up part of their salary in exchange for a benefit of some kind. This means that the amount of salary on which Income Tax or National Insurance is paid comes down, which in turn means that whatever is “purchased” with the sacrificed salary is paid out of pre-tax, pre-National Insurance income. The result can be saving of Income Tax at up to 45%, and National Insurance at up to 13.8%.
Over the years, the use of salary sacrifice has expanded, from initially covering items related to the workplace, like additional pension contributions or health screening, to the present situation where it is possible (in some organisations) to buy your fridge or mobile phone this way.
In the Autumn Statement, the Chancellor announced that salary sacrifice arrangements would be reined in, so the tax advantages will only now be available for pensions (and pensions advice), childcare vouchers, ultra-low emission cars, and the cycle to work scheme.
A better way to make pension contributions?
Employees’ pension contributions get tax relief irrespective of the way in which they are made. However, by making a contribution via salary sacrifice, both the company and the employee save NI contributions on the payment, which can be up to 13.8% for the employer and 12% for the employee. In some cases the employer may decide to pass on all or part of their savings to the employee, further reducing the cost of the pension.
As an example, let’s look at an employee earning £43,000 a year, and paying £300 a month into their pension. Making the contributions via salary sacrifice would save them £432 a year in National Insurance contributions, and their employer £497. If the employer passes on the National Insurance savings, then after taking account of tax relief, a pension contribution of £4,500 would only cost the employee £2,671.
For those paying tax at the higher or additional rate, making pension contributions through salary sacrifice can also speed up the receipt of tax relief. Salary sacrifice pension contributions effectively receive tax relief immediately, while for payments made from income, the relief at higher and additional rates has to wait until the tax return is submitted, up to 22 months after the payment was made.
Other benefits
Salary sacrifice works by actually reducing an employee’s income. There can be several additional benefits from this: it can mean that income falls below the level at which the personal allowance is reduced, thus taking some income out of an effective 60% tax rate.
Salary sacrifice can also bring income below the point where repayments of student loans become due, or below the relevant threshold for some means-tested benefits such as child benefit.
Downsides
There are downsides to salary sacrifice, the main one being that the lower level of contractual salary may cause problems when providing proof of income when applying for a mortgage. Some mortgage lenders may be prepared to take account of sacrificed salary. Income protection insurance may only pay out on the lower, post-sacrifice level of income.
A salary sacrifice arrangement is an actual change to an employee’s contract. There is no obligation on the employer to reverse the arrangement and reinstate the salary. Issues may also arise when pay-rises are given; should a percentage pay-rise be applied to the salary pre- or post-sacrifice?
So there are several issues to take into account, but if you are an employee making pension contributions, it could be worth discussing salary sacrifice with your employer.
If you would like to discuss any issues raised by this article, do please get in touch.
This article does not constitute advice, and no action or lack of action should be taken as a result of what is written. You are strongly advised to consult your financial adviser or a solicitor before taking any action relating to the matters discussed in this article. The information is based on our current understanding of HM Revenue & Customs practice. Any tax relief is subject to your individual circumstances and can change.