When I wrote recently about the advantages of salary sacrifice schemes, I didn’t have figures for the potential gains.
Now I do, and they’re certainly compelling, with a gain of 30% in annual pension for no extra personal contributions.
Salary sacrifice is where you agree with your employer that they will pay you less but at the same time the employer will make a contribution to your pension plan.
Lower pay means less National Insurance (NI) contributions both for you and the employer. Usually, the employer adds all the NI savings to the amount they contribute.
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A practical example
Take the case of someone earning £30,000 a year, so they pay income tax at 20%. If they get paid £1,000 a year less, they pay £200 less in income tax; they pay £110 less in NI; and their employer pays £128 less in NI.
With most salary sacrifice schemes, the employer would pay £1,238 into the employee’s pension fund - the salary ‘sacrificed’ plus all the NI savings.
I’ve now been provided by Hargreaves Lansdown with figures for the benefit from a typical salary sacrifice scheme. The table shows the figures for a man aged 30 who is at present contributing £100 per month to a pension scheme.
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Tax added back
Tax relief is added back, so £125 is invested in the plan. Salary sacrifice means he gets paid £100 less per month after tax, but the employer puts £163 into the pension plan.
So the employee is no worse off, but more money is going into his pension plan.
That means, on reasonably conservative assumptions, that at age 65 he will have a pension fund worth £124,500 rather than £84,600 and will have a retirement income for life that is 30% greater.
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Salary sacrifice at 30
30-year old male standard rate taxpayer making £100 per month net contributions to a pension scheme.
Monthly contribution | Fund Value | Pension at 65: Income | Pension at 65: Increase |
Personal contribution: £125 | £95,668 | £7,383 | NA |
Salary sacrifice before 2011: £163 | £124,571 | £9,613 | +30% |
Salary sacrifice after 2011: £165 | £126,282 | £9,745 | +32% |
Assumptions: 6% pa real annual growth net of charges. Annuity rate 7.7%. Source: Hargreaves Lansdown
A 30% gain for a little jiggery-pokery may strike you as a pretty good return, but as my previous article mentioned, there are wrinkles.
An employer really has to run a scheme for all employees, and very few are doing so at present. But that is probably going to change and if you are offered the opportunity to participate in such a scheme, it may be the best chance you get to enhance your pension at no cost to yourself.
After 2011, when both employer’s and employee’s NI contributions rise, the advantage of salary sacrifice becomes a bit greater, leading to a 32% enhancement as a result of using the scheme.
The gains for people paying higher rate tax are not as high in percentage terms at about 15%, because they only benefit from the NI savings, not savings in personal tax.
But because they will usually be saving larger amounts, the monetary savings can still be very large, and a 15% gain in retirement income for life is well worth having.
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