Salary Sacrifice to Avoid 40% TB

markuss91

Hi,

I haven't posted on this forum for a long time but I'm stuck on a financial decision and I'm hoping for some advice/second opinions/other angles. This could have fitted into many categories but seemed most relevant in this one.

I currently earn £70k which is the only household income for my wife and I, and we also now have a little one under 1. I am also a homeowner with ~50% equity in a house valued at ~£225k.

I'm in a defined pension contribution scheme whereby I pay 5% and my employer pays 5% and have a Plan 1 student loan of 9%.

I feel in a healthy position financially but I'm wondering if I can be more efficient or doing better anywhere, and one thing that triggered this is missing out on child benefit and now becoming aware that I can actually still receive this should I salary sacrifice down to 50k (my employer allows SS).

I don't mind paying more into my pension as I'm hoping to build up a large pension pot regardless as my wife doesn't work (well, earns a little through self-employment, but nothing significant for all intents and purposes of this post).

I am wondering if it's worth salary sacrificing my £70k salary down to £50k by voluntarily paying the excess into my pension, thus avoiding the 40% TB altogether (I understand this isn't as lucrative as a pure 20% saving due to considering NI effects too, more around 10% (maybe more due to student loan relief).

The first question is obviously can we afford to live on the reduced take home pay, which is yes, bur only providing I remortgage (which is due for renewal in 6 months) from a very short 10yr term (~£1,200pm to a 30yr term (~£550pm).

I've read that pensions can typically return ~7% annually over the long-term (thinking 20yrs+), highly likely over ~5%, which seems a no brainer to prioritise this given mortgage rates are ~4.5%.

It seems a no brainer as I type this out, but am I missing something? Like most I suspect, I just always liked paying more off my mortgage and reducing the amount of interest paid (as over the long-term it's sickening!) but now I feel my 'emotion' tied to this is driving me to make a poor long-term decision financially by prioritising my mortgage over my pension (and the high tax relief and child benefits that come in doing the latter via SS).

Is it a solid decision to change my approach and pay less into my mortgage but pay a lot more into my pension, thus avoiding 40% TB and unlocking child benefit too?

If the answer is yes, a second question I have is with regards to annual bonuses, to save me creeping up beyond £50k pa due to bonuses, do most employers let you SS the bonus amount straight into your pension?

Thanks in advance!
Mark

Newbie_John

I'm kind of in similar case to yours, and also had these thoughts for some time.

Lets say your salary after pension is at £60k, so you're missing on £1k of child benefit - if you shifted £10k into pension you'd become eligible.
You pay 40% tax on that £10k = £4k. If you moved it to pension and followed the simple rules to avoid any tax (when withdrawing) on it then you'd be better of by £5k putting it to pension (+all possible growth).

Now it all comes down to question - what's better £5k now or £10k (I skip the growth to simplify the case, let's assume it matches inflation) in the future?

If you have solid savings (emergency funds, life insurances), not planning to do any expensive purchases - larger house, private school fees, cars, you are sure you could keep decent salary till your pension age, then yes, it makes more sense to pay to pension - but if you're not there yet - it would make more sense to build all these up and then reconsider such move.

amanda1024

One thing to note for your wife is that if she claims child benefit, even if you then have to pay it back, this would mean she’d get the National Insurance credits to build up entitlement to state pension.

Another thing to consider is whether you’re likely to pay off your student loan in the next few years, because if so you might be better off continuing with your current income/pension contributions and current student loan and mortgage repayments for now, and looking to do the extra pension once you’re done with the student loan - that way it won’t have such a drastic impact on your mortgage. On the other hand, if you’ve a chance of some of the loan being written off, reducing repayments as much as possible until the write-off date makes sense.

Ultimately it comes down to individual preferences - for my own part, I found it very satisfying to pay off my student loan (and have an extra few hundred pounds a month!), and I’d be reluctant to commit to such a long mortgage term.

jamesd

Salary sacrifice also reduces your student loan repayments.

NI is calculated for each pay period, not annually. This means that you can get some 12% employee NI saving by concentrating your sacrifice into as few months as possible at minimum wage.

The longer mortgage term can be a good in part because by using the 25% tax free lump sum from the pension you can get pension tax relief on your mortgage capital repayments.

I retired five years ago and I'll be keeping my mortgage until its end date to maximise the potential investment benefit.

If you can't afford to keep CB every year you can do high year and low year combining to do it in some years. You could also just go down to eliminating your higher rate income tax liability and accept some CB reduction in some years. 

Most people wouldn't want to do it but you could also subsidise this plan by increasing your mortgage amount.

markuss91

Thanks for all your comments, the £5k now or £10k in the future is a very good analogy of how to think/approach this.

I’m not close to paying off my Plan 1 SL but it will be written off some 10 years before the 25yr cut off point (without SS down to 50k).

We do plan to move to a bigger home in ~3yrs, price range ~400k - £450k for what we need which we should be able to borrow given the equity we have built up in this home due to tying ourselves into a short mortgage term originally (seems an unwise move now, but I guess it’s done it’s job in building up a good deposit for the eventual family home which was the main reason we did it to avoid spending temptations in our 20s!).

I think it makes sense to SS down to 50k now to ‘turbocharge’ my pension for the next 3yrs, then reassess when we come to move home as we will likely need more disposable income to afford the mortgage. This is when the ‘having less money now rather than more money later’ will be more valuable to us to fund the family home we desire.

I think this a good short term approach to charge my pension over the next few years in a very tax efficient way. I don’t like the idea of sticking to 50k forever as we won’t have enough cash to fully enjoy ourselves/make memories as a family until I retire (and I also won’t ‘feel’ our bonuses or pay rises!) but planning to do this for 3yrs for now sounds sensible.

Last question, is it as simple as telling my employer that any annual bonuses are to go straight into my pension as salary sacrifice? If they send it to me first it’ll take me over 50k and undo all my effort in avoiding this tax trap due to loss of CB.

Prism

markuss91 said:

Last question, is it as simple as telling my employer that any annual bonuses are to go straight into my pension as salary sacrifice? If they send it to me first it’ll take me over 50k and undo all my effort in avoiding this tax trap due to loss of CB.

It might be but not all companies allow changing the salary sacrifice amount that often. I use salary sacrifce for core contributions and a SIPP to catch any bonus or other overpayments which I contribute to just once a year in March.

Archerychick

markuss91 said:

Last question, is it as simple as telling my employer that any annual bonuses are to go straight into my pension as salary sacrifice? If they send it to me first it’ll take me over 50k and undo all my effort in avoiding this tax trap due to loss of CB.

It is in my workplace, but your company may have different processes that they follow. You may need to fill in a form as a one off, or every year, just check with payroll/hr depending on where the responsibility sits 

markuss91

Thanks all, I will check with my employer.

I’ll also look into SIPPs too which I’ve never bothered looking into (probably like most who have a defined constriction pension through work).

jamesd

Mine allowed a change every month if wanted. If they understand the NI benefit of concentrating contributions they may be willing to accept more changes from those who are changing in year to benefit from that.

El_Torro

My employer didn’t used to allow us to Sal sac our bonus, a few years ago they started allowing it though. I have to fill in a form saying what percentage of my bonus I want to sacrifice each year. If I don’t fill the form in then the default is 0%. I also don’t know for sure what the bonus will be before the deadline for submitting the form, which is a fun guessing game.

Pension / mortgage is a balancing act. Many people on MSE (not this particular sub forum) like to get the mortgage paid off ASAP, which financially speaking is a bad idea, more often than not. Since you’re planning to upsize your property / mortgage soon I would think carefully about what you consider a manageable mortgage balance to be. 

Remember your wife can also pay in £2,880 into a pension, which with tax relief becomes £3,600. Both of you having a pension is more tax efficient than just one of you having a pension, even if one of the pensions is pretty small by comparison.

Albermarle

I've read that pensions can typically return ~7% annually over the long-term (thinking 20yrs+), highly likely over ~5%, which seems a no brainer to prioritise this given mortgage rates are ~4.5%.

A pension in itself does not return anything, it is the investments within the pension. So the potential return is dependent on the choice of investments within the pension, and how well they perform in the long term.

Also a figure of 7% will typically be before inflation is taken into account. So the real return would be less than that.

In the last 2 years a typical middle of the road pension fund is probably flat in nominal terms, but has lost nearly 20% in value due to inflation. Now hopefully this has not been a typical period and long term it will be better, but nothing is guaranteed.