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Salary sacrifice

Pension plans and SIPPs in particular are closely linked with tax planning especially so for higher rate tax payers and particularly after the changes announced in The Budget 2009.

For an explanation of the new rules for individuals earnings in excess of £150,000 from 6th April 2011 and the anti forestalling measures introduced for 2009/10 and 2010/11 please see here.

One of the simplest forms of tax planning is known as salary sacrifice (also known as bonus sacrifice and salary or bonus exchange) and is available to employees as a means of boosting employer pension contributions at no cost to the employer.

Whilst there are rules in place to prevent abuse salary sacrifice is endorsed by HMRC and gives opportunities for tax savings and National Insurance Contributions (NIC) savings to boost pension contributions.

The concept of salary or bonus sacrifice is simple enough; an employee agrees to a reduction in future salary or bonus in exchange for employer pension contributions. For example if an employee was paying 5% of gross salary into a SIPP or personal pension; this contribution would cease, the employee’s gross salary would reduce by 5% and the employer would pay the same amount plus the employer NIC saving into the SIPP or personal pension.

The employee would benefit from the employee NIC saving which could be 1% if the employee’s total earnings exceed £844 per week or £43,875 per annum.

The reduction in salary or bonus is a variation of the contract of employment and should be documented by an exchange of letter between the employer and employee. As part of our advice process we are able to provide a draft letter for use.

Since employer’s contributions to a registered pension scheme are exempt from NIC for the employer and employee it is common for the employer to add the employer NIC saving to the contribution.

Form an employee’s NIC perspective those with earnings over the Upper Earnings Limit (£43,875 in 2009/10) benefit the most from salary sacrifice. This is because the 1% NIC levied above this income level is effectively a tax on employment since no state benefits accrue as a result of the NIC payment.

Employees sacrificing salary below the Upper Earnings Limit could be losing state benefits as a result of the reduction in salary and this should be borne in mind.

Salary sacrifice may also affect your ability to raise mortgage finance and any salary related benefits such as death in service and income protection benefits from employment.

Looking forward NIC is set to increase from 2011 which will increase the attraction of salary sacrifice arrangements.

Example.

In 2009 / 2010 an employee earns £50,000 and is entitled to a basic personal allowance; the employer and employee pay 5% of the salary each into a personal pension.

The total cost to the employer would be circa £58,167 p.a.

The employee’s net pay would be circa £34,310 p.a.

Total pension contributions would be £2,500 gross for the employee and £2,500 for the employer.

If the employee re-directed the current contribution as an employer contribution and reduced his gross pay by the contribution amount the new employer contribution would be £5,367.71 p.a. and there would be no change to the employee’s net income or the employer’s cost.

Expert Financial Solutions Ltd offers expert advice on retirement savings, salary sacrifice, and bonus sacrifice arrangements. Our professional and highly qualified financial planning advisers will help you to make the most of the tax planning opportunities available to you to boost your retirement savings.

Expert Financial Solutions Ltd Chartered Financial Planners and independent financial advisers advise many high earners and high net worth clients on their pension and retirement savings. Our highly qualified and professional financial planners are pension experts and have the highest level of pension qualifications including G60 advanced financial planning certificate pensions, and AF3 advanced diploma in financial planning pensions.

Our Expert pension advisers offer advice to employees and employers on salary and bonus sacrifice arrangements.

The future

From April 2010 if an individual earns more than £100,000 their personal allowance will reduce by 50p per £1 over the limit.

Those individuals earning over £112,950 will see their personal allowance wiped out entirely.

What this means is that there is a band of income where the marginal rate of tax is 60% with the additional 20% (above the 40%) created by each £1 that pushes another 50p into the 40% bracket.

Someone earnings £112,950 will therefore pay tax of £38,240 while an individual earning £100,000 will pay £30,470 clearly increasing the attraction of salary sacrifice.

In this case sacrificing salary of £12,950 to reduce gross pay to the £100,000 threshold will save tax of £7,770 employer NIC of £1,657and employee NIC of £129 allowing clients to keep their personal allowance and avoid the punitive marginal tax rate of 60%.

We calculate that salary sacrifice for those earning between £44,000 and £100,000 in 2010/11 will give an effective rate of relief of around 47% on pension contributions.

This effective rate of relief increases to around 65% for those in the £100,000 plus earnings bracket; looked at another way this is £1 of pension contribution for a 35p commitment from the client.

Most clients would find that quite attractive………

September 2009