Salary sacrifice vs deduction at source - query

ConfusedbyHMRC

Hello all, new here so hello to you all

I have a question that I have been struggling with for some time, having moved company 18 months ago and gone from salary sacrifice to paying into my pension after PAYE has been deducted.

I have always read that making payments into a pension after tax is broadly the same for tax purposes as salary sacrifice (the difference being NI).

My situation, simplified slightly for rounding, is as follows.

Total Gross Income in the year (including benefits interest etc) - £140k

Pension contributions made in the year out of my after tax salary - £32k *1.25 = £40k

I have just done my preliminary tax return for the year which has come out with a cash income tax charge of £35k

Were I to have made salary sacrifice contributions of £40k to reduce my taxable income to £100k, a simple salary calculator for the tax due on £100k gives £27k as the cash tax due.

There is an £8k gap here (£35k-£27k) and i am wondering whether is is:

a) I am doing my tax return wrong (I put £40k in as my pension contribution, as it asked for the grossed up amount)

b) there really is an £8k difference in my tax charge doing it via post tax earnings

I have been round the houses with Chat GPT and seem to have confused it!

Thanks in advance for any insight from those cleverer than me

Best

El_Torro

I'm not sure I'm cleverer than you but I'll give it a go:

You're right in saying that you shouldn't see an £8k difference in these two methods of contributing to your pension. This means that there are other factors at play. What is your tax code? Is HMRC making assumptions about how much you are putting into your pension every year? Assumptions based on what you have told them presumably.

EDIT: If you are basing this based on what a salary calculator says maybe you are simply not taking into account that a £40k pension contribution allows you to claim back £8k in tax relief? On top of the £8k that your pension platform will get in tax relief.

DRS1

With relief at source pension contributions you have to claim the higher rate tax relief. There is an online form for this if you don't do self assessment. The £8k difference is that higher rate tax relief.

Albermarle

Thanks in advance for any insight from those cleverer than me

Total Gross Income in the year (including benefits interest etc) - £140k

You must be quite clever to be earning four times the average wage 😉

cc123mm456

I'll have a try at explaining the 2 methods. I'm assuming that you are not in Scotland.

For information, the method of paying into the pension after PAYE tax has been calculated and deducted is known as Relief at source (RaS)

Method 1 - Salary Sacrifice
You agreed with your employer to receive a reduced salary, and your employer paid the amount of that reduction in to your pension as an employer contribution. This means the amount was never included in your taxable pay calculation. Therefore as you have not paid tax on it, there is no need to claim any tax reliefs. In this case, the numbers are:

• Reference Salary (for information only, between you and your employer): £140,000
• Actual Salary: (reported to HMRC): £100,000
• Pension balance increased by £40,000 of additional employer contributions

Tax paid for the year:

• Personal Allowance: £12,570 at 0%
• Basic Rate: £37,700 at 20% = £7,540
• Higher Rate: £49,730 at 40% = £19,982

Total tax paid: £27,432

Method 2 - Relief at Source
When the pension is paid out of taxed income using RaS, there are tax relief adjustments to be made after the payment. The numbers are:

• Actual Salary: (reported to HMRC): £140,000
• Employee RaS Pension contribution: £32,000
• Tax relief claimed by the pension scheme: £8,000 (meaning the total increase to the pension balance is £40,000)

Your personal tax relief claim:
You will report to HMRC (via your tax return, or another method) that your payment to a RaS pension scheme was £40,000 gross. This will result in a change to your tax position so that you only pay the basic rate tax on that contribution (rather than higher rate).

The mechanism that HMRC use is to increase your basic rate band by £40,000. So your tax bands will be

• Personal Allowance: £12,570 at 0%
• Basic Rate: £77,700 at 20% = £15,540
• Higher Rate: £49,730 at 40% = £19,982

This results in your payment of tax on that contribution of £40,000 x 20% = £8,000, which is equivalent to the tax relief claimed by the pension scheme.

Total tax paid £35,432 (but £8,000 extra pay was received, because your pension contribution was lower, so the net effect is £27,432 when compared to the Salary Sacrifice method).

............
The process is complicated a little because, until HMRC are made aware of the contribution and adjust your tax position, you could be paying 45% tax on the earnings above £125,140, and also your personal allowance would have been reduced to zero for a gross salary over £125,140. Both of these will no longer apply after the amendment for the RaS contribution.

I hope that this helps

ConfusedbyHMRC

Hi all of you and thanks a lot for taking the time to come back to me.

cc123mm456 I think yours is the easiest for me to follow up on.

Method 1 - fully agree and that is what i would expect to be the case. I would just add to that that the tax on £100k is £27k

Method 2 - Looks like the bands you describe are the same as in my draft tax return. 77k @ 20% = 15,400 plus 50k @ 40% = 20,000. This gives me a tax charge of £35k

So does this mean that under method 2 my tax liability for the year really is £8k higher than if I had sacrificed salary?

Thanks again

cc123mm456

Yes the tax will be £8,000 higher, but remember you received pay that was £8,000 higher. The pension contributions deducted from your pay were £32,000 instead of £40,000

That £8,000 additional tax is the same £8,000 that is claimed by the pension scheme.

I've added some tax numbers to my calculations to show the impact on overall pay. In both cases the end net position is the same.

Edit: Before someone mentions it, I'm only referring to the overall impact on the net pay and tax. I'm aware that with salary sacrifice, there is a saving in NIC, but if the employer doesn't offer Sal Sac, there's nothing that can be done about that.

PUGXS_22

Please accept my apologies, I don't wish to hijack this thread. I was about to post something very similar to the OP's original post and realised to avoid criticism of 'not reading' other threads, it would be better to add to this thread….

I think I have a similar situation (please note that values are rounded so dont flame me for the non-reconciling maths!):

My total taxable income for the year was £166k, with ~£55k tax paid.

To bring my ANI to <£100k and avoid losing my 30 hours free childcare, I decided to pay £55,000 into my SIPP at YE (~£69k gross contribution).

I had in my head that £166k - £69k would be £97k ANI and the tax due would be ~£26k.

When I then compare £26k tax due to £55k tax paid I was expecting a sizeable refund!

However, my refund is ~£14k which is in line with the higher rate tax relief of the gross pension contribution I made.

After lots of reading and Chat-GPT'ing I have started to come to the conclusion that my original assumption was incorrect and that the pension contribution doesn't reduce taxable income, instead it shifts the tax bands and that my original 'estimate' of a large refund was completely flawed?!

Before I push submit on my tax return at the lower refund I would be grateful if somebody could confirm that I am not on the right lines of thinking please? I would hate to think I am leaving a bigger refund on the table but am 80% confident I have just simply gotten it wrong when assuming I would be taxed at £97k income…..please put me out of my misery!! 😂

On a second note, it does make me question if I would have been better off just putting it all through a work salary sacrifice scheme - but my head hurts from all the maths now, so cannot tell!! 🙈

cc123mm456

@PUGXS_22 It's probably better in a separate thread, to avoid confusion, but anyway…

When your salary is over £100,000, there is a significant benefit by making pension contributions, where possible, to bring the Net Adjusted Income to below £100,000 to avoid the 60% tax trap, as well as to qualify for the childcare.

If the employer offers the option, then contributing via Salary Sacrifice is better, because there is also a NIC saving in addition to the tax saving. However the employer might only offer Salary Sacrifice against a regular contribution. If they do offer it against a one-off contribution, they would have a deadline for the request, probably at least month or more before the tax year end. So in that situation, a SIPP contribution can be worthwhile.

A point to be mentioned is that your contribution amount is over £60,000, which is the usual annual limit for pension contributions. You may have some carry forward of previous years allowance that can be used, and I'll leave the discussion of the carry forward for others to comment on. It is a complex rule.

So the following assumes that carry forward is permitted (and you are not in Scotland):

Without Pension Contribution:

	Tax Band	Tax Rate	Tax
Personal Allowance:	£0	0%	£0
Basic Rate	£37,700	20%	£7,540
Higher Rate	£87,440	40%	£34,976
Additional rate	£40,860	45%	£18,387
Totals	£166,000		£60,903

After Pension contribution of £55,000 net / £68,750 gross (Adjusted Net Income:£97,250)

	Tax Band	Tax Rate	Tax
Personal Allowance:	£12,570	0%	£0
Basic Rate (37,700 + 68,750)	£106,450	20%	£21,290
Higher Rate	£46,980	40%	£18,792
Additional rate	£0	45%	£0
	£166,000		£40,082

Reduction in tax paid:	£20,821
Tax relief paid in to SIPP:	£13,750
Total tax saving:	£34,571

DRS1

On a second note, it does make me question if I would have been better off just putting it all through a work salary sacrifice scheme - but my head hurts from all the maths now, so cannot tell!! 🙈

As @cc123mm456 pointed out you might have saved a bit of NIC. The NIC saving will be closed off at some time but you could still take advantage of it this tax year.

Also spreading the contributions over a period may help rather than having to find £50k in one go near the end of a tax year.

As also pointed out you are going to need to watch out for the Annual Allowance if you are making personal contributions of over £60k in a tax year. The Annual Allowance does not just take into account personal contributions it also looks at employer contributions (assuming your all pensions are defined contribution schemes). So if the employer is making contributions totalling say £16k in a year then your £68750 contribution in 25/6 means you have used up £84750 of the Annual Allowance - ie you went over by £24750. That £24750 is hopefully covered by unused Annual Allowance from one or more of the previous three tax years. You would need to do the sums to see if that works and bear in mind that the Annual Allowance wasn't always as high as £60k (for 22/3 it was £40k). Before deciding you can do the same again for 26/7 you should make sure you will have enough Annual Allowance left (with carry forward) to cover your and your employer's contributions.

HL have a handy calculator

Pension Carry Forward & Annual Allowance Calculator | HL

PUGXS_22

@cc123mm456 - sorry, I thought it would have been better etiquette to put the question in a similar thread. Have been criticised on other forums for doing so before. Was always going to be 50/50 chance.

Thank you to both of you - you have both provided very helpful and comprehensive answers.

Yes - I also have 16% total contributions (employer and employee) going into a workplace SS scheme. However, I have more than enough carry over from the previous 3 years to accommodate.

The answers lead me to a couple more questions:

1. Did I need to do anything in my SA to recognise the available carryover or is it on the individual to have checked and self assessed?
2. @cc123mm456 - do your calculations suggest I should be receiving £34.5k back??