| Salary sacrifice, a tax-efficient way of making an additional contribution to your pension pot, is becoming increasingly popular following the relaxation of contribution limits as part of the A-Day pension reforms.
There has been no change to the salary sacrifice rules themselves but the previous contribution limits meant that the scheme was more a bonus sacrifice arrangement – with high earners putting their annual bonuses into their pension – rather than making a monthly salary payment.
Now a growing number of companies are setting up flexible benefits packages that include a salary sacrifice element for their employees.
Under a salary sacrifice arrangement, employees agree that part of their salary will be paid directly into their pension schemes by their employer. The employees, meanwhile, stop making their previous pension contribution.
Because the amount sacrificed is no longer being paid as salary, the employer is no longer required to pay their 12.8 per cent National Insurance contribution on the amount sacrificed. So this can be added to the employees’ pensions at no additional cost to the company or the individuals. In addition, the employees no longer pay National Insurance on the sacrificed amount.
Some employers might add the entire 12.8 per cent to the amount paid into the employees’ pensions; others could retain an amount to cover their costs of administering the scheme.
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Before the simplification of pensions rules on A-Day – last 6 April– contributions into a personal pension were limited to a percentage of the individual’s salary, rising from 17.5 per cent to 40 per cent over the age of 50. The tax-free limits have now been increased to 100 per cent of salary with a maximum in any one year of £215,000.
Salary sacrifice was always part of the pensions regime but before A-Day it was a double-edged sword, because contributions were based on salary. If you gave up your salary you could not contribute so much, but now you have far greater limits.
The relaxation of contribution limits is expected to benefit high earners, but the way in which NI contributions are structured offers an incentive to those earning less than the NI threshold of £645 a week, or £33,540 a year.
People earning below this level (but more than the £97 a week – £5,044 a year – at which contributions start) pay 11 per cent of salary as their National Insurance contribution in addition to the employer’s 12.8 per cent. Those earning more than £33,540 a year pay only 1 per cent on the top slice of their earnings.
Employees could consider the option of putting their end-year bonuses into salary sacrifice schemes next March/April. Business owners could also switch from taking dividends out of their companies to paying themselves bonuses which they put into their pensions through a salary sacrifice arrangement. This can be attractive now that the company can fund up to £215,000 a year.
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