Millions of workers could be wasting hundreds of pounds a year each if they pay into a company pension, as employers are failing to help them save efficiently.
Rather than simply paying their contributions from their standard wage, many employees will benefit by using what is known as a salary sacrifice scheme, says financial adviser firm Hargreaves Lansdown (HL).
Research from HL shows just 15% of employers sampled that operate a workplace pension use a salary sacrifice scheme. However, there are risks with such arrangements.
How does salary sacrifice work?
Your official salary is reduced by the amount of your contributions, which are paid directly to your pension by your employer.
Therefore, contributions are not subject to tax or National Insurance (NI).
Say you earned £40,000 a year but wanted to contribute £5,000 into your company pension, your salary would become £35,000, with the remaining £5,000 deposited straight into your retirement pot.
Salary sacrifice is normally only available on money purchase pension schemes where your contributions go into a fund which is invested and (hopefully) grows. Those on a final salary pension are unlikely to benefit from this arrangement as it is not usually available, HL says.
What are the savings?
You already get tax relief on pension contributions, usually paid directly into your pension pot. The savings from salary sacrifice come from not paying NI. The benefit is more pronounced for basic rate taxpayers.
- Basic rate taxpayers. As anyone in this category pays 11% NI, that is the amount you would save on your contributions. On the example above, you would save £550 a year in NI on that £5,000, compared to not using a salary sacrifice scheme.
- Higher rate taxpayers. Here, you pay 1% on your earnings above £43,888. If you earned £50,000 a year and contributed £5,000 into your pension, the NI saving is £50 a year.
Higher rate taxpayers, who pay 40% tax, would normally only be given the basic 20% relief and they'd need to claim the further 20% themselves. With salary sacrifice, as you don't pay tax anyway, this saves the hassle of claiming.
Savings will be even greater from April 2011 because NI rates will rise by 0.5 percentage points for everyone. And from next April, those earning just over £100,000 will lose their personal allowance, the portion they pay no tax on, at a rate of £1 for every £2 earned. This group could therefore gain further from a salary sacrifice scheme.
Is salary sacrifice best for everyone?
As your official wage is lower, there are a number of possible downsides to consider. Salary sacrifice could:
- harm applications for mortgages, credit cards and loans.
- mean lower sick pay, maternity pay and overtime rates.
- reduce entitlements to salary-related benefits such as death in service.
- lower your entitlement to the Second State Pension.
Even if your employer operates a salary sacrifice scheme and it is not right for you, you can usually still save in the normal fashion.
Martin Lewis, MoneySavingExpert.com creator, says: "If salary sacrifice is best for you, discuss it with your employer as there's no additional cost for them, just some admin hassle."
Employers benefit too
It is not just employees who reap the rewards. Employers do not have to pay the 12.8% NI on the amount of your contributions. They could either keep the cash themselves or add it to your pension.
Laith Khalaf, HL pensions analyst, says: "Employers can make their pension arrangements more efficient using salary sacrifice. The savings can be retained, passed on to staff or shared."
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