Salary sacrifice - what's the catch?

jamesd

Salary sacrifice is a good thing, but often misunderstood.

Your net pay could stay the same or it could increase:

1. If it increased, that would be because the company was keeping the amount going into the pension the same, then the lower tax bil means you'd end up with more net pay because you wouldn't be paying NI on the money going into the pension.

2. If it stayed the same, that would be because the company was adding the saved NI to the pension pot. So you'd have more in the pension pot and same net pay.

A company contributing its full NI saving is good. Contributing half is quite common, as is contributing none of it.

Your employer seems to be treating you generously and that is a good clue that it's probably a good idea unless you are on a low income, when some of the benefits issues can matter sometimes. Those low income issues are one good reason why switching to salary sacrifice is an option for you, not mandated. Though it's usually mandated as the only way to do it, so again it seems that your employer is being kind.

Under the salary sacrifice rules before the summer of 2012 it wasn't permitted to change pension contributions during the benefit year except as a result of a significant life change. That was changed over the summer by HMRC because it was incompatible with the auto-enrolment rules, which require employees to have the right to start and stop paying into a pension during the year. So HMRC now says that pension changes make no difference to whether a scheme is or isn't a valid drawdown scheme. But your employer still might not want you to change amounts rather than fully start or stop, best to ask them.

perfume_waggon

Hi JamesD and thanks for your reply. I agree that my employer is very generous and I realise I’m very lucky.

I still don’t understand how, if I increase my percentage contribution from 7.5% to 12% my net pay stays the same? And it seems that even if I increase the percentage contribution further the net salary can stay the same? Surely there has to come a point where the figures stop balancing out?

Zero_Sum

perfume_waggon wrote: »

Hi JamesD and thanks for your reply. I agree that my employer is very generous and I realise I’m very lucky.

I still don’t understand how, if I increase my percentage contribution from 7.5% to 12% my net pay stays the same? And it seems that even if I increase the percentage contribution further the net salary can stay the same? Surely there has to come a point where the figures stop balancing out?

No it won't

jamesd

A change from 7.5% to 12% could reduce your net pay.

Say you were paying 7.5% gross now, ignoring any employer contribution. If you're a basic rate tax payer the net cost to you is 7.5% less 20% basic rate tax, so multiply 7.5% by (1 - 0.20) and you get a net pay cost of 6%.

Now say you switch to salary sacrifice and kept 7.5% of your gross pay going in, plus any extra employer NI going in as well. Now you save the employee NI as well. Your net cost is now 7.5 times ( 1 - 0.20 - 0.12 ) = 5.1%, so your net pay rises bu the difference between 5.1% and 6%. And if your employer is paying in their saved employer 13.8% NI the amount in your pension pot increases by 7.5% times 1.138 = 8.535%. So more money in the pension for lower net cost to you.

Now, that's 8.535% for 5.1% of pay. Say you wanted the pension to get 12% of gross pay in salary sacrifice? The net pay cost for that is 12 / 8.535 * 5.1 = 7.17% of net pay.

Say you wanted to keep the net pay cost at the same 6%. Then you could have 6 * 8.535 / 5.1 = 10.04% of gross pay going into the pension. Because some of that 10.04% is the employer NI part you'd ask for 10.04 / 1.138 = 8.82% of gross pay to go in and the employer top up would take it up to the 10.04%.

If you're a higher rate tax payer the calculations differ a bit.

perfume_waggon

Thanks again Jamesd that's very helpful. I am a higher rate taxpayer - is it too cheeky to ask for the revised calculations?

jamesd

It's not too cheeky to try it yourself and let others check your calculation...

GUYd

Salary sacrifice (SS) is a very tax efficient way of contributing to your pension if you are a higher rate tax payer.
I currently SS everything that falls into the 40% tax bracket into my SIPP. Not only does this save tax on my income but also savings on NI.
In addition, my employer passes on all of his NI saving (currently 13.8%). This is what makes a significant difference.

So for example:
If I was earning a salary of £60,000.

My income tax for 2012/13 would be:
• 0% on the first £8,105 = £0
• 20% on the next £34,370 = £6,874
• 40% on the final £17,525 = £7,010
Total income tax bill: £13,884

My NI for 2012/13 would be:
• 0% on the first £7,605 = £0
• 12% on the next £34,870 = £4,184
• 2% on the final £17,525 = £350
My NI bill = £4,534

My employer’s national insurance is:
• 0% on the first £7,488 = £0
• 13.8% on the next £52,512 = £7,247
My employer’s NI bill = £7,247

So, I want to SS £17,525 of my gross salary to avoid paying any higher rate income tax. In addition, my employer will pass on his NI savings.

So savings on £17,525 include:
£7,010 income tax
£350 NI saving (employee)
plus a contribution of £2418.45 from my employers NI saving
Therefore total savings on a sacrifice of £17,525 gross salary = £9,778.45

This equates to a 56% tax saving

In addition, if you have dependants then sacrificing down to at least £50k/annum means that you will avoid losing child benefit - increasing your savings further!!

Zero_Sum

perfume_waggon wrote: »

Thanks again Jamesd that's very helpful. I am a higher rate taxpayer - is it too cheeky to ask for the revised calculations?

I've got a net salary calculator spreadsheet. If you want to play around with percentages. (Even though it says 13/14, there is a 12/13 comparison colun)
http://zerosum.freewebspace.com/

perfume_waggon

Ok, here goes, don't laugh.

Using Jamesd's calculations adapted for a 40% taxpayer:

Salary sacrifice of 7.5%
7.5*(1-0.4-0.12) = 3.6% net pay cost.
Employer NI = 7.5%*1.138 = 8.535%
So that's 8.535% for 3.6% of pay.

Salary sacrifice of 12%
12/8.535*3.6 = 5.06% of net pay?
(Why isn't this 12*(1-0.4-0.12) = 5.76%?)

GUYd - thanks for your calculations. I've used them with my salary and it reinforces what a great deal it is. I never doubted it was, I'm just confused by the example pay slip I've been shown, but I think I'll have to discuss this with my employer.

Zero Sum - thanks for the spreadsheet. Should the % contribution be the total contribution, i.e. mine and my employer's, or just mine? I can't seem to get it to agree with my pay slip.

Thanks again everyone for taking the time to help.

Zero_Sum

perfume_waggon wrote: »

Zero Sum - thanks for the spreadsheet. Should the % contribution be the total contribution, i.e. mine and my employer's, or just mine? I can't seem to get it to agree with my pay slip.

Thanks again everyone for taking the time to help.

Just the employees conts

Its only been tested with contracted out non sal sac pension, which it seems to be working. If you've changed tax codes mid year, that can knock things out a bit.