27th May 2016 at 3:00pm
While certain famous equations, such as Albert Einstein’s E = mc2 might make sense to the mathematicians, when it comes to our retirement savings there’s an equation that could make sense to us all.
Pension + Salary Sacrifice = a free boost to retirement savings
Take a break
Pensions already enjoy generous tax breaks compared to other long term savings products. But factor in the National Insurance (NI) savings from salary sacrifice and you get a tax deal that’s hard to beat.
- Using salary sacrifice means basic rate taxpayers can enjoy tax relief of 32% on their pension payments. So a £100 pension top-up only costs £68.
- Higher rate taxpayers get 42% tax relief from salary sacrifice, meaning it only costs £58 to add £100 to your pension.
- And the employer saves NI too; some of this might be passed on as an extra pension top-up.
So confirmation in the March Budget that pension salary sacrifice was not under any immediate threat was welcome news indeed.
If you are in a workplace pension, and your employer offers salary sacrifice, be sure to consider whether you are making the most of the additional boost this gives to your retirement savings.
It won’t be right for everyone. There can be drawbacks. For example, you might not be able to revert to you old (pre-sacrifice) salary if your circumstances change. And it might reduce your ability to get a loan or affect your entitlement to some State benefits. But it could be right for you.
How does salary sacrifice work?
Salary sacrifice is actually quite simple. If your employer offers it, you agree to change your employment contract to give up part of your salary in return for an extra employer contribution to your pension.
As your salary is reduced, you and your employer pay less National Insurance. This means you can pay more into your pension at no extra cost.
Here’s the maths
Let’s look at what this equation could look like in monetary terms.
Olivia is 35 and earns £36,000 a year. She pays 5% of this salary into her workplace pension (£150 a month/£1,800 a year).
If Olivia agreed to do salary sacrifice on her current pension contributions she’d save NI of £216 a year.
This means Olivia can continue to have £150 paid into her pension each month and see her monthly take home pay go up by £18 (the NI saving).
Pay more in at no extra cost
OR, she could choose to boost her pension with the NI savings, leaving her with the same take home pay as before and a bigger pension to look forward to.
With the additional boost to pension funding which salary sacrifice can provide on top of income tax relief, it doesn’t take a genius like Einstein to work out that it is a very effective and efficient means of saving for retirement.
Finding the right formula
Match up salary sacrifice with your pension and it could indeed be a formula that fits, from both you and your employer’s perspective. It’s certainly worth doing the maths.
This blog and any responses to comments should not be regarded as financial advice. Law and tax rules may change in the future. The information here is based on our understanding in May 2016. Your personal circumstances also have an impact on tax treatment.
A LISA and a pension are investments. The value of investments can go up or down and may be worth less than you paid in. Past performance is not a reliable indicator of future performance.