Salary sacrifice is a perfectly legal method of taking advantage of the national insurance system to the benefit of pension scheme members.
Salary, bonus, commission, company car/ car allowance, profit share & medical insurance are all taxable benefits. If an employer provides them the employee will pay tax and national insurance (NI) on their value. The employer will also pay employer’s NI on these benefits.
If an employer makes a pension contribution on behalf of an employee there is no tax and no NI for the employee, the employer receives full tax relief on the contribution as an allowable business expense and moreover the employer pays no employer NI on the pension contribution either.
Thus if an employee exchanges (sacrifices/ diverts) an amount of salary and the employer instead makes a pension contribution of a similar amount on that employee’s behalf there will be a saving in employer NI, employee NI and (a modest amount of) income tax. This saving is then available to pay into the employee’s pension in addition.
Salary diversion could slightly reduce your entitlement to statutory benefits, means tested benefits, tax credits or other salary related benefits: for example entitlement to mortgages. So always seek individual professional advice before action.
Here is a worked example based on the 2019/2020 tax Year. Here the employee is on a salary of £30,000 per annum and contributes 3% to pension. The employer pays 5% – both percentages here based on total earnings. Remember in auto enrolment cases employers may not require or make a pension contribution on the first £6,136 of salary (as they are only required to base contributions on qualifying earnings – those between £6,136 and £50,000 in 2019/2020)
Using salary diversion puts an extra £304.94 into pension every year for free!
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