Is it advisable to forgo your current income for a larger retirement benefit?
Kick your personal finances up a notch with salary sacrifice, an ingenious tactic to beef up your bank account, and it might be just what you're searching for if you're pondering how to splurge your annual bonus.
The beauty of this strategy lies in its ability to reduce your income tax and National Insurance deductions, allowing you to get more bang for your buck. Salary sacrifice is most often utilized for boosting pension contributions, but its versatility knows no bounds.
"Many employers flaunt salary exchange, another name for salary sacrifice," says Clare Moffat, a pensions and tax guru at Royal London. "It's when you agree to relinquish part of your salary, and your employer covers the entire pension contribution instead of you chipping in a portion."
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Employers appreciate salary sacrifice as it enables them to shower their employees with perks without raising salaries, a move many are hesitant about considering the government's hike in employers' National Insurance contributions (NICs).
"With the Chancellor's decision to escalate employer contributions to National Insurance, the allure of salary sacrifice has grown exponentially," says Lisa Caplan, a financial shrewdness mastermind at Charles Stanley.
Research indicates that 30% of DIY investors would opt for salary sacrifice to bolster their savings. Of these, a fifth confess they already have access to a scheme but aren't using it, with plans to do so. A further 10% admit their employer doesn't yet offer salary sacrifice, but they express interest if it was an option.
So, what exactly is salary sacrifice, and how can it aid in supercharging your pension savings and providing access to other appealing perks?
What in tarnation is salary sacrifice?
Salary sacrifice is a mutually agreed contract to lower your cash payment, usually in exchange for non-cash benefits like increased pension contributions, medical insurance, or even a car.
"Salary sacrifice is a nifty stealth move to get more dough into your pension, with no additional burdens," says Moffat.
"The advantage is that you pay less income tax and National Insurance because your salary is reduced prior to tax and National Insurance being deducted. Your employer also coughs up less employers' National Insurance, and they might pass a part or all of this savings onto you."
High-tax payers who are part of a group personal pension receive an extra bonus, as they receive all the tax relief rather than having to claim anything above basic rate back from HMRC.
"Many high and additional taxpayers with group personal pensions overlook the fact that they must file a claim for their tax relief back, and they're missing out," says Moffatt.
Moffatt paints a hypothetical scenario regarding Maria, who earns £35,000 and is a resident of England during the 2024/25 tax year. Maria's employer returns half of the National Insurance savings to employees.
"She forks over tax, National Insurance, and an employee pension contribution of £1,400 and her employer bestows £1,050 into her pension. This means Maria has a net pay of £27,320. If she takes the salary sacrifice approach, her gross pay slips to just under £33,056. She made no pension contributions whatsoever as her employer covers it all.
"Despite the diminished gross pay, Maria's net pay remains at £27,320. The reduced tax and National Insurance expenses result in an additional £3,129 being funneled into her pension instead of £2,450."
Is salary sacrifice just for your pension?
While most associate salary sacrifice with pension contributions, it can be applied to a myriad of other benefits.
For instance, there are electric car schemes via salary sacrifice, where employees waive some pre-tax salary in exchange for the monthly lease on an electric vehicle (EV). Such schemes help employers lease EVs from manufacturers, with the same tax advantages that pension salary sacrifice entails.
Other salary sacrifice schemes include cycle to work schemes, work nursery schemes, which assist with the costs of childcare, or technology schemes to help break the bank on a new phone or laptop.
Can you use salary sacrifice on your bonus?
If you've bagged a bonus, you may be questioning the best way to spend it. Some employers offer bonus exchange schemes, which operate much like salary sacrifice – but without chopping your regular income.
"The key elements to consider are immediate financial priorities like debt that you might wish to settle forthwith," Susan Hope, a retirement authority at Scottish Widows, opines to our website.
"Secondly, when you'll require this cash, perhaps for emergency savings or savings goals in the intermediate term.
"If it's cash you don't require for any of those types of things, using salary sacrifice to channel it into your pension could not only beef up your pot, but for high earners, it could also help with tax obligations, childcare benefits, and personal allowance."
For a basic taxpayer, funneling a £5,000 bonus via salary sacrifice into a pension during the 2024/25 tax year might yield a £6,090 pension contribution, or a £6,150 contribution from 2025/26, once the adjustments in employer and employee NICs are taken into account.
The versatility of salary sacrifice extends beyond pensions, enabling individuals to invest in benefits like medical insurance or electric vehicles. For instance, electric car schemes offer monthly leases on EVs through salary sacrifice, providing tax advantages similar to those on pension contributions.
With a bonus in hand, one might consider using a bonus exchange scheme, which functions akin to salary sacrifice but does not reduce regular income. This method can help boost pension savings, lighten tax obligations, and optimize childcare benefits for high earners.
