Salary Sacrifice??

xylophone

http://www.thisismoney.co.uk/money/guides/article-3487365/Britain-s-pay-rise-low-earners-need-know-national-living-wage-improved-minimum-mage.html

Annual Minimum Wage seems to be based on 35 x NMW x 52.

DrDoom1973

Thanks for the reply! I have reservations that HMRC would accept this calculation, its simply too general and all encompassing.

I would imagine that they would look at hours worked over a period of time and divide by that , I have seen 12 weeks as a suggestion on some other sites.

JWman

Apologies in advance for what may appear to be stupid questions. As a family we are creatively thinking about our finances for the near future (next three years).

Much to my shame, I have spent very little time concerning myself with pensions and tax planning.

My basic salary is circa £100,000 per annum, and I paid over £40,000 in tax last year.

I am currently making a modest contribution to my pension circa £750/month

I understand the higher rate tax of 40% kicks-in around the £32,000.

So the blue-sky thinking is this:
1. Is there anything stopping me making a salary sacrifice of £68,000 in a tax year (£5,600 per month), so as to reduce the tax contribution and maximise the pension contribution?
2. If this continued for three years and say the pension has increased by £210,000 (after three years), could I take this out tax free in order to pay off my mortgage?
3. What would be the risks, restrictions of doing this?

I guess you see where these questions are leading…three years of severe family financial austerity could mean a major change in circumstances in 3 years, at which time I will be 56 years old, and mortgage free.

I would appreciate any ideas or pitfalls on my thinking.

JWman

Paul_Herring

Is there anything stopping me making a salary sacrifice of £68,000 in a tax year

The £40,000 (gross) limit. (Though you probably have some years you could carry forward at the start you probably could contribute more initially.)

greenglide

... and remember that on withdrawing the cash from the pension it is subject to tax as well.

Compressing three years salary into one like this would mean a horrendous tax hit.

What is your current plan for paying the mortgage - assuming you had one?

MoneySavingUser

JWman wrote: »

So the blue-sky thinking is this:
1. Is there anything stopping me making a salary sacrifice of £68,000 in a tax year (£5,600 per month), so as to reduce the tax contribution and maximise the pension contribution?
2. If this continued for three years and say the pension has increased by £210,000 (after three years), could I take this out tax free in order to pay off my mortgage?
3. What would be the risks, restrictions of doing this?

1. As has been mentioned there is a £40,000 gross limit per tax year. You can carry forward any unused allowance from the last three tax years.

This is a gross limit so it includes your contribution and tax relief and any employer contributions.

So if we assume you have paid £750 pre-tax through the payroll and your employer has paid the same amount for you each month:

In the previous tax year you would have paid 12 * £750 * 2 = £18,000 so you would have £40,000 - £18,000 = £22,000 to carry forward to this year. The same calculation can be done for the previous two tax years. I think the limit might have been £50,000 in one of those.

You should contact your pension provider and ask for confirmation of how much has been paid in to the pension in total including employer pension contributions in the previous 3 tax years (though if you are using salary sacrifice they will all be classed as employer contributions).

a) Are you currently paying the £750 per month through salary sacrifice?
b) How much does your employer pay in? Do they have a limit on how much they will match?

2. If your pension provider offers the new pension freedoms then maybe:

c) Is your scheme a defined benefit or defined contribution scheme? if it is a defined contribution scheme can you pay AVCs?

You can normally take out up to 25% of your pension as tax-free cash so you would need a pension fund of £840,000 in total (if it is a defined contribution scheme) to be able to take out £210,000 tax-free.

3. Restriction is the £40,000 limit for you.

There is another limit which kicks in at £150,000 (which is pay plus employer contributions) which reduces the £40,000 so that would be an issue if your pay is likely to jump in the next few years.

Risks are reduction is disposable income, salary sacrifice amends your contract and not all employers allow you to change the amounts sacrificed as often as you want (i.e. some allow it only once per year).

=====

In my opinion what you are planning to do is a good idea. At the moment you are paying 42% tax on your top slice of income (40% income tax and 2% national insurance).

You most likely won't be able to do it at the levels you are thinking and won't be able to take it all out tax-free but you will be able to do something.

i.e. lets say your employer will put in £10k/year. That let's you put in £30k/year so after 3 years you will have saved £37,800 in tax! of this you can take 25% of it back out tax-free and the rest would be taxed at 20% most likely if you waited until you retired and were in a lower tax bracket then.

So yes, you are on the right lines just it will likely have to be on a smaller scale.

ex-pat_scot

JWman wrote: »

Apologies in advance for what may appear to be stupid questions. As a family we are creatively thinking about our finances for the near future (next three years).

Much to my shame, I have spent very little time concerning myself with pensions and tax planning.

No shame. Today is the first day of sorting yourself out.

JWman wrote: »

My basic salary is circa £100,000 per annum, and I paid over £40,000 in tax last year.

as well as a shed lot of NI.
You are in one of the "sweet spots" where pension contributions can have a huge benefit.


Once your salary exceeds £100,000 pa then your personal allowance is gradually reduced. This means that the effective tax rate for salary between £100k and (roughly) £130k is 60%, not 40%. Plus the 2% NI as well.


So what? Well - if you are losing 62 pence in the pound for every pound earned in this bracket, then conversely you would gain much more from pension tax relief.
Regardless of any other considerations, a sensible person in your situation would bring your salary (gross plus BIK plus bonus, LESS pension contributions) down to £100,000.


Careful planning might be required here - for example if significant bonuses are paid or are volatile in amount/ timing.

JWman wrote: »

I am currently making a modest contribution to my pension circa £750/month

That's £9000 pa, plus whatever your company contributes.
Yes - it's modest compared with your salary.
It's still a decent start.


As others have noted, you can get tax relief on up to £40,000 pa pension contribution (ie company plus employee contributions).


IF YOU ALREADY HAVE HAD A PENSION IN PLACE FOR THOSE PRIOR YEARS, then you can pay more, up to the total level of your salary, by "carrying back" the excess contributions over £40k, for the last 3 years.
Thus: if you had £9,000 contributions last year, you could carry back £31,000 from this year's earnings into your last year's entitlement. And so on, for the last 3 years.


(NB read further on this - I've grossly simplified it).
(NB 2 - remember that the company contributions count towards your annual limit)
(NB 3 - this might mean in theory that you can put £100,000 (being £40,000 of this year's allowance, plus unused allowances from the last year) into your pension. And then you realise there's nothing in your current account to pay the mortgage or to buy food.)

JWman wrote: »

I understand the higher rate tax of 40% kicks-in around the £32,000.

No. BR tax kicks in around £11,000.
HR tax kicks in around £43,000.
You pay no tax on £11,000
You pay BR tax on (43,000-11,000) ie c£32,000.
You pay HR tax on everything above £43,000


It then gets very messy around the £100,000 to £130,000 mark, when it settles down again, then increases to 45% on everything above £150,000.

JWman wrote: »

So the blue-sky thinking is this:
1. Is there anything stopping me making a salary sacrifice of £68,000 in a tax year (£5,600 per month), so as to reduce the tax contribution and maximise the pension contribution?

As noted above, (a) you can perhaps make this payment if you have the ability to carry back, but (b) the income threshold for HR tax is £43,000 NOT £32,000 hence (at £100,000 earnings) you would get HR relief on £57,000 and BR on anything above.



BONUS TIME:
IF you have children eligible for Child Benefit, and earn under £50,000 then you get full CB.
IF you earn £60,000 + then you get no CB.
Hence, if you have children eligible, and can reduce your salary to £50,000 then you would also be able to claim CB, which makes the additional pension contribution especially valuable in this band.
Just a thought.

JWman wrote: »

2. If this continued for three years and say the pension has increased by £210,000 (after three years), could I take this out tax free in order to pay off my mortgage?

You can access your pension at 55.
You can then take 25% of the pot tax free.
Anything beyond the 25% would be taxed at your marginal (highest) tax rate.

That would mean that if you took (say) £200,000 out of your pension, and were still earning £100,000 pa, then unless your pot was sufficiently large (>£800,000) that this remained part of your 25% tax free lump sum, then you would be paying SIGNIFICANT tax on some of the withdrawal.
Significant = 60% on some of it; 45% on other bits of it.
This is not effective or efficient.

JWman wrote: »

3. What would be the risks, restrictions of doing this?

Risks - once you crystallise your pension pot, then you are restricted to £10,000 pa contributions from then on.
ie if you are 55 and draw the 25%, and continue to work, then you can only contribute £10,000 pa from then on.


Depleting your pension specifically to pay off the mortgage might well be fine, but could leave your pension rather low in funds.
It's not a bad strategy - I think it was the reason that the 25% tax free lump sum was originally in place. But it's not the only approach to financial planning.
Beware that rules can and will change.
Pension tax relief is at threat. It was surprising that the March 2016 budget did not attack it: some think it's only a short matter of time before it comes into the chancellor's radar again.
The 25% tax free lump sum might also come under fire.

You are 55 in 2 years' time.
Frankly, you are in the enviable position of only being exposed to such political / tax risks for a short period of time, as you can access your pot at any time from 55. This means that you are nimble in reacting to some of these issues.
Some of us have a fair bit longer until we hit 55, so are more exposed to potential changes in the pensions regime.

JWman wrote: »

I guess you see where these questions are leading…three years of severe family financial austerity could mean a major change in circumstances in 3 years, at which time I will be 56 years old, and mortgage free.

I would appreciate any ideas or pitfalls on my thinking.

"Severe financial austerity". I know what you mean, but remember there are plenty for whom your level of austerity would be peachy. It's all about lifestyle and choice.

If you have a second family income, then this becomes more manageable.

If you can manage to do this under Salary Sacrifice, then you will also benefit from employee NI saving, and possibly (depending on the generosity of your employer) employer NI saving. THat's a big amount too.

MoneySavingUser

Thanks expat-scot - good points about the need to be a member of a scheme in prior years to use the c/forward and the triggering of the MPAA when you crystallise funds, both of which I missed.

Though I think it is possible to avoid the restriction to £10,000 if you only take the tax free cash element?

[quote[Where a tax-free lump sum is desired and can be taken as a pension-commencement lump sum this may be paid without triggering the MPAA rules. The related amount can be crystallised into flexi-access drawdown without affecting the annual allowance rules until income is taken. Once income has been taken then the new MPAA rules will apply.[/quote]

http://www.pruadviser.co.uk/content/knowledge/oracle_archive/oracle-technical/oracle-tech-september-14/money-purchase-annual-allowance/#

jamesd

Yes, you can take the 25% tax free lump sum without triggering the reduced MPAA.

If there are children you can possibly get back child benefit payments. You can also do things like varying the amount paid in each year so that some years you get back the CB while other years you don't, so that you stay within the pension contribution limits by building up available carry forward of MPAA.

You might also look into use of VCTs. They have the advantage of being available after five years without having to repay the 30% initial tax relief you get and some are available that pay out around 10% tax exempt income. The five year period means that you can get that 30% many times during your life.

ex-pat_scot

jamesd wrote: »

Yes, you can take the 25% tax free lump sum without triggering the reduced MPAA.

If there are children you can possibly get back child benefit payments. You can also do things like varying the amount paid in each year so that some years you get back the CB while other years you don't, so that you stay within the pension contribution limits by building up available carry forward of MPAA.

You might also look into use of VCTs. They have the advantage of being available after five years without having to repay the 30% initial tax relief you get and some are available that pay out around 10% tax exempt income. The five year period means that you can get that 30% many times during your life.

I wasn't aware of the ability to crystallise without triggering the MPAA. That's possibly very useful to me as a risk reduction strategy - knowing that at 55 I can at least access some of the pot whilst continuing to work and feed the full amount into the pot.
You never quite know what will happen in future budgets, so the ability to access your funds is quite comforting.


As for the CB, it can make a huge difference.
With lots of children, my marginal "tax" rate for my income between £50,000 and £60,000 is roughly 78% (more if sal sacrifice gets you the ers NI back). ie for the £10,000 I earn in that band, I get £2,200 in my pay packet.


As you note, you can get clever with playing around with carry back. This is awkward in practice, as you may well be losing out on company matching of contributions, and many (most?) HR departments don't take kindly to regular changing of contributions (mine only allows changes once a year in December).