Should you forgo a larger pension in exchange for a higher salary?

Salary sacrifice is a growingly popular strategy for lowering taxes and increasing pension contributions as employers' National Insurance is expected to increase

One of the best ways to increase your personal wealth is to sacrifice your salary. If you're unsure of how to spend your yearly bonus, this is something you should give careful thought to.

Salary sacrifice is an extremely effective way to save money because it lowers your income tax liability, which gives you more money for your money. Although salary sacrifice can be used for a number of purposes, it is most frequently used to boost pension contributions.

"Salary sacrifice, also known as salary exchange, is offered by many employers," says Clare Moffat, a pensions and tax specialist at Royal London. "Instead of you paying some and your employer paying some, you agree to exchange a portion of your salary, and your employer then pays the entire pension contribution.

Employers should consider salary sacrifice because it allows them to provide more benefits to their staff without raising wages, something that many are currently hesitant to do due to the government's increase in employers' National Insurance contributions (NICs).

The appeal of salary sacrifice has significantly increased since the Chancellor's decision to increase employer contributions to National Insurance, according to Lisa Caplan, a financial planner at Charles Stanley.

According to research from Charles Stanley Direct, 30% of do-it-yourself investors would choose to participate in a salary sacrifice plan to increase their savings. A fifth of these claim that their employer already provides a plan that they intend to use but do not currently use. Ten percent more say that although their employer does not currently offer salary sacrifice, they would choose to do so if it did.

However, how can you increase your pension savings and obtain additional benefits through salary sacrifice?

What is sacrifice of salary?

Salary sacrifice is a contract that lowers your pay in exchange for a non-cash benefit. Pension contributions, health insurance, or even a car could fall under this category.

"Salary exchange is a way for more money to go into your pension but without any extra cost," Moffatt remarks.

It has the advantage of lowering your income tax and national insurance premiums. This is because national insurance and taxes are deducted from your pay before they are paid. Additionally, your employer may pass on some or all of the savings to you in the form of lower employers' national insurance premiums.

Because they receive all the tax relief instead of having to claim anything above the basic rate back from HMRC, higher or additional rate taxpayers who are enrolled in a group personal pension additionally benefit.

"Many higher and additional rate taxpayers with group personal pensions are losing out because they forget that they need to claim their tax relief back," Moffatt says.

In the 2024 - 2025 tax year, Moffatt uses the fictitious example of Maria, who lives in England and makes £35,000. Maria's employer gives workers a 50% refund of their National Insurance savings.

"Her employer contributes 1,050 to her pension, and she pays 1,400 in employee pension contributions, taxes, and national insurance. Accordingly, Maria's take-home pay is £27,320. She will receive less moneyjust under £33,056if she decides to exchange her salary. Her employer pays for her pension, so she doesn't contribute anything.

Maria's net income remains at 27,320. But instead of 2,450, 3,129 is now going into her pension due to tax and National Insurance savings. Maria would save money on taxes and national insurance even if her employer didn't pay her a portion of the savings.

According to new statistics from Scottish Widows, employees who choose to participate in their employers' salary exchange program could increase their pension pots by 41,200 more than a year's average salary.

Simply choosing to participate in their employers' salary exchange program could increase the take-home pay of average salary workers, who currently earn 37,4301 annually, by 150. Their pension savings would increase by 528 annually if this additional money were put into their pension pot in addition to the savings the employer receives from lower national insurance contributions.

Assuming a 5% growth rate in investments, a worker who retires at age 67 and is 30 years old would have an additional 41,200 in pension savings. Those who choose to enroll ten years later, at age forty, would see their pension fund increase by £24,500.

The figures highlight the beneficial impact these schemes have on employees' financial empowerment, especially in light of recent HMRC research that has cast doubt on the future of salary exchange.

According to a survey conducted by Scottish Widows, 79 percent of employees who participate in salary exchange stated that it gives them greater confidence in their ability to maximize their pension savings and manage their money in a tax-efficient manner.

Does salary sacrifice only apply to your pension?

Salary sacrifice can be applied to a variety of other benefits, although most people tend to associate it with pension contributions.

Salary sacrifice electric car schemes, for instance, allow employees to forgo a portion of their pre-tax income in exchange for a monthly lease on an electric vehicle (EV). With the same tax benefits that pension salary sacrifice provides, these allow employers to lease electric vehicles (EVs) from manufacturers and for employees to lease EVs from the employer.

Workplace nursery programs, which provide assistance with childcare costs, cycle to work programs, and technology programs that could help spread the cost of a new laptop or phone are examples of additional salary sacrifice programs.

Is it possible to apply salary sacrifice to your bonus?

If you received a bonus recently, you might be unsure of how to spend it. With the added benefit of not lowering your monthly income, some companies provide a bonus exchange program that offers advantages comparable to salary exchange.

According to Susan Hope, retirement specialist at Scottish Widows, "the important things to think about are immediate financial priorities like debt which you may want to pay off immediately," she tells BFIA.

"The second is the potential need for this money, such as emergency savings or medium-term savings objectives.

Using salary exchange to contribute money to your pension could increase your pot and, for higher earners, also help with taxes, childcare benefits, and personal allowance if the money is money you don't need for any of those kinds of things.

When employer and employee NIC reductions are taken into consideration, a basic rate taxpayer who pays directly into a pension using salary exchange may convert a 5,000 bonus into a 6,090 pension contribution in the 2024 - 2025 tax year, or a 6,150 contribution from 2025 - 2026.