Your pensions are one of the most powerful tools you have at your disposal when saving for retirement. This is because, as well as your own monthly payments, you may benefit from employer contributions and tax relief.
Additionally, the wealth you save in your pensions is invested, so it could potentially grow over time. You also don’t pay Income Tax or Capital Gains Tax (CGT) on the returns from investments in your pensions.
Ultimately, this could mean that you’re able to build a much larger savings pot than you would have done if you held your wealth outside of your pensions.
Consequently, you could be missing an opportunity to increase your contributions without affecting your take-home pay if you’re not aware of “salary sacrifice”.
This is a potentially more tax-efficient way to contribute to your pension that may benefit you and your employer. Unfortunately, FTAdviser reports that 22% of UK workers have never heard of salary sacrifice, and 31% have heard of it but know very little about it.
Fortunately, if your employer offers a salary sacrifice scheme, it should be relatively easy for you to opt in. And if you do, you could significantly increase your pension savings.
Read on to learn how salary sacrifice works and why it could mean that you’re able to retire earlier.
Salary sacrifice allows you to exchange a portion of your earnings for certain benefits
Salary sacrifice is a scheme that employers may offer, and it allows you to give up (or sacrifice) part of your salary in exchange for other benefits. This could include a company car, private healthcare, cycle to work schemes, or pension contributions.
For example, instead of earning a salary of £50,000, you might elect to receive a salary of £47,000 and “sacrifice” £3,000 as pension contributions.
When used to pay into your pensions, salary sacrifice could increase your contributions without affecting your take-home pay. In fact, you might see your monthly income increase.
This is because, typically, your employer deducts your Income Tax, National Insurance contributions (NICs), and pension contributions from your salary and then pays you the net amount.
However, when you use salary sacrifice, you can give up a portion of your salary equal to your pension contributions, and your employer will pay this amount directly into your pension. In turn, Income Tax and NICs are calculated based on the lower salary, meaning you pay less tax and NICs.
As an additional benefit, your employer will pay lower NICs too. In some cases, they might use this additional saving to increase their contributions to your fund.
Consequently, by using salary sacrifice, you could reduce the tax you pay and potentially even increase your monthly income, while also maintaining the same pension contribution. Alternatively, you might increase the amount you pay into your pension, while your take-home pay remains the same.
Additionally, you could use salary sacrifice to make even larger pension contributions and reduce your salary so you can move into a lower tax bracket if you are close to the threshold.
Provided you use it in the right way, salary sacrifice could help you increase your pension savings faster and may even mean that you can retire earlier than planned.
Research reveals that salary sacrifice could help you retire a year early
When you create your financial plan, you may set an estimated date for retirement. New research shows that you might be able to bring this date forward by using salary sacrifice.
According to PensionsAge, if you have an annual salary of £34,963, salary sacrifice could increase your take-home pay by £140 a year. If you added this amount to your pension contribution, and your employer volunteered their NI saving, you would save an additional £463 a year.
Over 25 years, assuming average growth of 5.4%, this could add £35,900 – or around a year’s salary – to your retirement pot.
If you earn more than £34,963, the increase in your pension savings could be greater. As such, you might be able to reach your savings goal and retire earlier than planned.
There are some potential downsides of salary sacrifice you may need to consider
Salary sacrifice could be an excellent way to increase your retirement savings, but there are some potential downsides to consider.
Although your monthly income is the same, or higher than before, you’re technically reducing your salary. This could affect you in several ways.
For instance, if your employer offers life cover, the benefits your family would receive are often based on your salary. As such, your level of cover may be lower if you sacrifice a portion of your salary.
Your entitlement to certain benefits, such as Statutory Maternity or Paternity Pay, could also be affected.
Additionally, a lower salary might influence the amount that you can borrow in the future, as lenders typically base mortgage lending on a multiple of your salary. If your salary is lower, your borrowing potential may be reduced.
In many cases, the benefits of salary sacrifice could outweigh these downsides. However, you may want to seek professional advice and consider whether it’s the most suitable option for your financial plan.
Get in touch
We can help you explore the most tax-efficient ways to build your retirement savings.
Email enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
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