If you want to put more disposable income into your pension then a Salary sacrifice scheme maybe the solution.
Salary sacrifice schemes or salary exchange schemes are becoming more popular for employees looking to increase their pension contributions.
What is a salary sacrifice scheme?
A salary sacrifice pension scheme is an arrangement between you and your employer in which you agree to sacrifice an amount of your salary in exchange for certain non-cash benefits.
These can include some ‘in kind’ benefits such as childcare vouchers, bikes, ultra-low emissions vehicles or periods of annual leave, but also they can be payments into your pension.
How does a salary sacrifice pension work?
Once you’ve negotiated with your employer how much of your salary you wish to ‘sacrifice’, your monthly net pay is reduced by that amount, so you’ll pay less income tax and National Insurance on your earnings, too.
Your employer gains from this because they will pay less in National Insurance, and you benefit because there is more money available to go towards your pension that would ordinarily go to HMRC.
You should be able to negotiate with your employer how much of your salary to convert to pension payments. Some employers may have their own rules on when you can do this, So you will need to contact the company administrator of the scheme.
Salary sacrifice pension illustration
On a salary of £25,000 which is roughly £20,000 after tax, assume you currently put 5% or £1,000 (£1,000 + £250 tax relief at 20%) into your pension each year, and your employer contributes 3% resulting in a total of £2,000 into your pension each year.
If you were to switch to a typical salary sacrifice agreement then the following example may occur.
In your agreement with your employer you reduce your annual salary by £1,000, resulting in a gross annual salary of £24,000, or £19,200 after tax.
This is equivalent to around £70 per month in Net pay for a basic rate taxpayer.
Your 5% pension contribution is therefore reduced from £1,250 to £1,200 (£960 + £240 tax relief).
Your employer’s 3% contribution stays in place, PLUS the £1,000 you have sacrificed from your annual salary.
This results in total annual pension contributions of £2,920, which is £920 more into your pension each year than without salary sacrifice.
Is pension salary sacrifice the right retirement option for me?
One clear issue is that you will be paid less each month, so you need to make sure you have enough disposable income every month.If your salary is close to the minimum wage threshold, you may not qualify for salary sacrifice as all, as it’s illegal for your employer to pay you any less.
You will also need to take into account how salary sacrifice affects your lifetime pension contributions towards the state pension, as this is based on 35 years of earnings throughout your working life.