Salary sacrifice and earnings to keep in lower tax band

kiloton

Hi. Apologies to be asking another salary sacrifice question. 

Until my earnings really explode I want to get this idea clear in my head. The main part being salary sacrifice.

I am earning £49000 p/y
Invested in ISAs
Earning interest to take me up nearly to £50,270 higher earner tax band

I want to stay in lower tax band and also increase payment into workplace pension.

If I paid an extra £200 per month into pension using salary sacrifice would that in effect change my earnings from £49000 to £46600
Does this then mean I can I invest more money to earn interest and not go into higher tax band? So from other savings I could earn up to £3670? Whereas before the maximum I could have earned was £1270?

Thank you

Dazed_and_C0nfused

kiloton said:

Hi. Apologies to be asking another salary sacrifice question. 

Until my earnings really explode I want to get this idea clear in my head. The main part being salary sacrifice.

I am earning £49000 p/y
Invested in ISAs
Earning interest to take me up nearly to £50,270 higher earner tax band

I want to stay in lower tax band and also increase payment into workplace pension.

If I paid an extra £200 per month into pension using salary sacrifice would that in effect change my earnings from £49000 to £46600
Does this then mean I can I invest more money to earn interest and not go into higher tax band? So from other savings I could earn up to £3670? 

Thank you

You wouldn't be paying any extra pension contributions.

You would be agreeing to a reduced salary in return for extra employer contributions.  No tax relief is due (to you) on employer contributions.

But you would have less taxable pay and, on the figures you are referring to, avoid paying both tax and NI on the amount sacrificed.

kiloton

Ah, this is the bit that always confuses me, “ You would be agreeing to a reduced salary in return for extra employer contributions.” So I am no longer earning £49000 and putting the money in pension. The money, although it will be mine through a pension is paid without it reaching me at all? So I would be earning less cash in hand, so will be able to earn more interest on savings?

Bear with me; just thinking out loud and this probably reads exactly as you have said above :-)

tizerbelle

Are all your savings in ISA's? Interest earned in ISA's is tax free.  But if you have mis-typed and you aren't using ISA's, that would be one of your first actions to reduce any potential tax burden

kiloton

Sorry. Should have expanded further. I have maxed out ISA allowance.

i may be wrong in my thinking of all this but my idea is to max out tax free savings, use my savings allowance and keep my tax on earnings at 20% until I start earning much more than £50271.

CrickJon

kiloton said:

Hi. Apologies to be asking another salary sacrifice question. 

Until my earnings really explode I want to get this idea clear in my head. The main part being salary sacrifice.

I am earning £49000 p/y
Invested in ISAs
Earning interest to take me up nearly to £50,270 higher earner tax band

I want to stay in lower tax band and also increase payment into workplace pension.

If I paid an extra £200 per month into pension using salary sacrifice would that in effect change my earnings from £49000 to £46600
Does this then mean I can I invest more money to earn interest and not go into higher tax band? So from other savings I could earn up to £3670? Whereas before the maximum I could have earned was £1270?

Thank you

As you would be in the lower tax bracket, I think you’re entitled to £1k of interest anyway without it being taxed so you maybe have more room than you realize.

kiloton

I have taken the £1000 savings allowance into account. It is classed as earnings even though not taxed so any more earning via interest on savings would send me into higher tax band.

MX5huggy

You are basically right and have a right strategy, but I would be looking to Salary sacrifice more than just to get under the £50270. Because the Salary Sacrifice saves you both the Income tax and national insurance so 28% you should be pushing as much in to pension as you can afford probably at the detriment of other savings. The limit on SS is that you must still receive the equivalent of national minimum wage (£11.44 per hour) after the salary sacrifice. 

Exodi

kiloton said:

Ah, this is the bit that always confuses me, “ You would be agreeing to a reduced salary in return for extra employer contributions.” So I am no longer earning £49000 and putting the money in pension. The money, although it will be mine through a pension is paid without it reaching me at all? So I would be earning less cash in hand, so will be able to earn more interest on savings?

Bear with me; just thinking out loud and this probably reads exactly as you have said above :-)

Yes, that is the main benefit of salary sacrifice.

Normally you would be paid £49k, pay tax on £49k, and your pension contribution would be deducted out of your net pay and put into your pension pot as an employee contribution. You then automatically get the basic rate of income tax refunded (or you can apply for higher rate tax relief through a SA) as it's not fair for you to pay tax on the money you put into the pot, and also be liable to pay tax when you eventually take it out in retirement.

With Salary Sacrifice, you agree to have your salary reduced, to say £45k, and that is what you are paid through PAYE and charged tax on. Behind the scenes the employer puts the £4k sacrificed into your pension as an employer contribution (and obviously no tax relief is due as you never paid tax on it in the first place).

It gets a tad more complicated, but bear with me - one thing to remember is the employer will always make employer contributions (usually a percent of salary up to a point) in either case (but in the latter, they'll add their contribution to your salary sacrifice amount). Also while Income Tax is refunded in the former, NI is not (giving Salary Sacrifice a monetary advantage). Lastly, behind the scenes the employer has to pay 'Employer NI' on your pay... but if you reduce your pay through Salary Sacrifice, this reduces their tax liability, which many employers offer to share or give to their employee as another benefit.

Dazed_and_C0nfused

Exodi said:

kiloton said:

Ah, this is the bit that always confuses me, “ You would be agreeing to a reduced salary in return for extra employer contributions.” So I am no longer earning £49000 and putting the money in pension. The money, although it will be mine through a pension is paid without it reaching me at all? So I would be earning less cash in hand, so will be able to earn more interest on savings?

Bear with me; just thinking out loud and this probably reads exactly as you have said above :-)

Yes, that is the main benefit of salary sacrifice.

Normally you would be paid £49k, pay tax on £49k, and your pension contribution would be deducted out of your net pay and put into your pension pot as an employee contribution. You then automatically get the basic rate of income tax refunded (or you can apply for higher rate tax relief through a SA) as it's not fair for you to pay tax on the money you put into the pot, and also be liable to pay tax when you eventually take it out in retirement.

With Salary Sacrifice, you agree to have your salary reduced, to say £45k, and that is what you are paid through PAYE and charged tax on. Behind the scenes the employer puts the £4k sacrificed into your pension as an employer contribution (and obviously no tax relief is due as you never paid tax on it in the first place).

It gets a tad more complicated, but bear with me - one thing to remember is the employer will always make employer contributions (usually a percent of salary up to a point) in either case (but in the latter, they'll add their contribution to your salary sacrifice amount). Also while Income Tax is refunded in the former, NI is not (giving Salary Sacrifice a monetary advantage). Lastly, behind the scenes the employer has to pay 'Employer NI' on your pay... but if you reduce your pay through Salary Sacrifice, this reduces their tax liability, which many employers offer to share or give to their employee as another benefit.

Although I agree with most of that there is no income tax refund with relief at source pension contributions.

The pension company will add basic rate tax relief to tey net contributions but that is not a refund of any income tax paid.

Someone whose only taxable income is earnings of £12,500 could contribute £10k net and receive £2,500 in basic rate tax relief without paying a penny in tax.

Exodi

Dazed_and_C0nfused said:

Exodi said:

kiloton said:

Ah, this is the bit that always confuses me, “ You would be agreeing to a reduced salary in return for extra employer contributions.” So I am no longer earning £49000 and putting the money in pension. The money, although it will be mine through a pension is paid without it reaching me at all? So I would be earning less cash in hand, so will be able to earn more interest on savings?

Bear with me; just thinking out loud and this probably reads exactly as you have said above :-)

Yes, that is the main benefit of salary sacrifice.

Normally you would be paid £49k, pay tax on £49k, and your pension contribution would be deducted out of your net pay and put into your pension pot as an employee contribution. You then automatically get the basic rate of income tax refunded (or you can apply for higher rate tax relief through a SA) as it's not fair for you to pay tax on the money you put into the pot, and also be liable to pay tax when you eventually take it out in retirement.

With Salary Sacrifice, you agree to have your salary reduced, to say £45k, and that is what you are paid through PAYE and charged tax on. Behind the scenes the employer puts the £4k sacrificed into your pension as an employer contribution (and obviously no tax relief is due as you never paid tax on it in the first place).

It gets a tad more complicated, but bear with me - one thing to remember is the employer will always make employer contributions (usually a percent of salary up to a point) in either case (but in the latter, they'll add their contribution to your salary sacrifice amount). Also while Income Tax is refunded in the former, NI is not (giving Salary Sacrifice a monetary advantage). Lastly, behind the scenes the employer has to pay 'Employer NI' on your pay... but if you reduce your pay through Salary Sacrifice, this reduces their tax liability, which many employers offer to share or give to their employee as another benefit.

Although I agree with most of that there is no income tax refund with relief at source pension contributions.

The pension company will add basic rate tax relief to tey net contributions but that is not a refund of any income tax paid.

Someone whose only taxable income is earnings of £12,500 could contribute £10k net and receive £2,500 in basic rate tax relief without paying a penny in tax.

Maybe I've misunderstood you but I understood pension contributions (in a relief at source scheme) are deducted from an employees pay after tax is calculated - meaning the employee has paid income tax on their pension contribution.

When the amount is added to their pension pot, they are effectively claiming the income tax they have already paid on their pension contribution back. This ensures that they only ever pay tax on the same bit of income once (as otherwise they'd be paying tax on the money going into their pension, and then potentially paying tax on the same money going out when they draw on it in retirement). I think the reason tax relief is provided at the basic rate by default is just because of the administration of any alternative solution. Obviously if you earn more, you can claim higher rate tax relief through SA so it is clearly connected income tax paid.

The fact that someone who doesn't pay tax but can claim the default basic tax relief is just a quirk of a simplified system - the purpose behind it remains to reimburse people of the income tax they paid (hence why no tax relief for SS).

EDIT: On re-reading I think we actually both think the same thing, and might be dabbling in semantics rather than any form of disagreement.