Salary sacrifice is offered by some employers so their employees can receive increased pension scheme contributions.  It's not an effective way of saving for everyone so, if your employer offers salary sacrifice, you should make sure you benefit before signing up.

How salary sacrifice schemes work

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, if 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% and 100%, with most employers paying 50%.

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.

The disadvantages of salary sacrifice schemes

Salary sacrifice results in you having a lower salary.  This could affect the following:

  • Life cover/income protection  - 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, your life cover/income protection may reduce also.  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 is available if you earn above the Lower Earnings Limit (£5,668 in 2013/14) 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 (£5,668 in 2013/14) and the Upper Accrual Point (£40,040 in 2013/14) may affect this entitlement.

  • State Second Pension (S2P) – as with SMP if salary sacrifice brings your salary below the £5,668 in 2013/14, your entitlement to S2P may be lost.

What are National Insurance contributions (NIC)?

National Insurance contributions (NIC) help to pay for some state benefits including retirement pensions.  NIC that you pay can earn you the right to receive certain benefits.  You pay NIC between the ages of 16 and state pension age, you pay contributions on earnings (but not pensions).  The state pension age is currently 65 for a man.  The state pension age for a woman is increasing from 60 to 65.  After state pension age, even if you have a job you do not need to pay any more contributions.

What benefits do my contributions pay for?

To qualify for some UK state benefits, you need to have paid National Insurance contributions of a certain level.  These state benefits are called contributory benefits.  There are other benefits as well provided the rules for claiming these apply to you, it does not matter whether or not you have paid any or enough NIC. 

Benefits which do depend on NIC include:

  • Bereavement allowance/bereavement payment           
  • Contribution based jobseekers allowance
  • Contribution based employment and support allowance
  • Widow’s benefits
  • Basic state pension
  • Additional state pension

Benefits which do not depend on NIC include:

  • Attendance allowance and disability living allowance
  • Child benefit
  • Guardian’s allowance
  • Income based jobseeker’s allowance
  • Industrial injuries benefits
  • Carer’s allowance
  • Severe disablement allowance
  • Statutory payments (e.g. Statutory sick pay).

Will salary sacrifice arrangements always be a good idea for low earners?

No – salary sacrifice will not always be a good idea. You cannot participate in salary sacrifice schemes where your pay would be reduced below the National Minimum Wage (21+ = £6.31/Hr; 18-20 £5.03/Hr; <18 £3.72/Hr; Apprentice £2.68/Hr). 

The benefits for low earners are limited.  If earners are between the lower earnings limit (£5,668/yr 2013/13) and the earnings threshold (£7,748/yr), switching from cash to benefit will not save NICs, as contributions in this band attract a nil rate but still entitle benefits without actually paying them.  Where salary sacrifice reduces earnings below the lower earnings limit.  The employee falls out of the NIC benefits system and will mean that the employee will lose entitlement to contributory benefits and the state pension. 

Our Independent Financial Advisers are always happy to meet at our clients' preferred location and time and to have detailed initial discussions with no obligation.

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