If you’re saving into a workplace pension scheme, some of your salary will automatically be paid into your pension. However, you can save tax and increase the money that’s paid into your pension by giving up some of your salary or bonus before tax.
Salary sacrifice or exchange
How it works
Salary sacrifice is a slightly misleading name because you’re not giving up part of your salary – rather, you’re exchanging it for a non-cash benefit, such as additional pension contributions. So, you can see why it’s sometimes called salary exchange rather than salary sacrifice. You can use salary sacrifice for other non-financial benefits, such as the cycle to work scheme or a company car.
If you’re paid a bonus, you can also exchange some or all of your bonus for extra pension contributions. The advantage of salary sacrifice is that you’ll save on tax and national insurance, and your employer will save on national insurance as well. The saving comes because you exchange some of your salary for pension contributions before you’re taxed on it.
Your employer may pay some or all of the national insurance they’ll have saved into your pension, however they don’t have to do this. But they should tell you how giving up some of your salary in exchange for extra pension contributions would affect your take-home pay. That will help you to decide whether salary sacrifice is right for you.
Advantages and disadvantages
The main advantage of salary sacrifice is that you’ll save tax, but there are disadvantages as well, so it’s important to weigh these up before you go ahead.
- You’ll save tax and national insurance. The amount you save will depend on how much of your salary you sacrifice or exchange for pension contributions, and whether you’re a basic, higher or additional rate taxpayer.
- Your entitlement to statutory benefits (such as maternity pay) and salary-related benefits (such as life insurance from your employer and furlough payments) may be affected.
- Salary sacrifice may affect how much you’re able to borrow through a mortgage. However, some lenders may take your salary before salary exchange into account, rather than your lower salary.
Be aware that not everyone can qualify for salary sacrifice. The rules say that you can’t do salary sacrifice if it would mean that your salary would fall below the National Minimum Wage or National Living Wage levels. Additionally, it may not be suitable if you’re on furlough, because you can’t claim the exchanged portion of your salary.
Salary sacrifice and the Child Benefit High Income Tax Charge
If you claim Child Benefit and earn more than £50,000 a year, you may be able to save tax through salary sacrifice. Under the current rules, if you claim Child Benefit, and you earn more than £50,000 a year, you’ll incur a tax charge (called the Child Benefit High Income Tax Charge).
The tax charge also applies if you live with your partner, where one of you claims Child Benefit and one of you earns more than £50,000 a year (it doesn’t have to be the person who claims Child Benefit). Once you, or your partner, earn £60,000 or more a year, the tax charge wipes out the Child Benefit. However, you can effectively ‘reduce’ your salary for Child Benefit purposes, by making additional workplace pension contributions. The additional pension contributions don’t have to be paid through salary sacrifice, but it’s an option.
Bonus sacrifice works in a similar way to salary sacrifice, in that you decide to give up some or all of your bonus and have it paid into your pension instead. You won’t pay tax or national insurance on the portion of your bonus that you exchange.
How it works
You have to decide in advance of getting your bonus how much you want to exchange. Depending on when your employer tells you how much bonus you’ll receive, you may have to make this decision before you know how much bonus you’ll get. If that’s the case, you could say that you’d like a percentage of your bonus to be paid into your pension, or that you’d like an amount in pounds, up to a specific limit. For example, you might decide to exchange 50% of your bonus for extra pension contributions – or all of your bonus up to a limit of £10,000.
What to watch out for
Make sure that these extra pension contributions don’t take you over the £40,000 annual allowance for pensions. The current rules let you pay up to 100% of your salary, or £3,600 a year into your pension, whichever is higher, and still get tax relief. But there’s also a pensions annual allowance of £40,000, and if you pay more than this amount into your pension in any one tax year, you’ll be hit with a tax charge which is the equivalent of the tax relief you’ll have received on your pension. This £40,000 limit includes contributions made by your employer as well. It may sound complicated, but the main message is that you should check that salary or bonus exchange won’t take you over these limits.
Support and advice
If you have a financial adviser it’s a good idea to discuss salary or bonus sacrifice with them. If you don’t, but would like some advice, you can read about finding professional help in our guide on where to find an adviser.
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