Boost Your Pension For Free!

By sacrificing some of your salary you can boost your pension, save tax and national insurance, and still have the same take home pay into the bargain.

We all love the idea of getting something for nothing. Well, with something called 'salary sacrifice' you can do just that.

The scheme allows you to take a lower salary in return for an additional pension contribution. And it can be done in such a way that your take home pay can actually stay the same. Clever huh! What's more, the advantages of salary sacrifice don't stop there. The scheme can also be used for child care costs and environmentally-friendly travel to work.

So how does the scheme work?

Essentially you agree with your employer to sacrifice a proportion of your salary in return for a non-cash benefit. This is beneficial to you because the non-cash benefit is exempt from income tax and national insurance (NI). It also works to your employer's advantage as it will be able to make valuable savings on its NI bill too.  

It's this tax bonus which enables you to boost your pension without reducing your take home pay.

Salary Sacrifice And Pensions

In the context of your pension, salary sacrifice involves giving up part of your salary by the amount of your pension contributions which are then paid to your scheme directly by your employer. Even better, a larger contribution can be made which has no impact on your take home salary. This can be achieved since your employer has the option to pay all - or at least some - of the NI saving into your pension plan.

The example below illustrates how this works based on the new tax rates for 2008/09. Imagine you earn £40,000 and every month a contribution of £100 is made into your pension. By sacrificing some of your salary, here's what happens:

Source: Standard Life. Assumptions: NI thresholds and tax allowances are increases as outlined in HMT press notice issued 18/10/07. Income tax thresholds increase in 2008/09 by 4%. The basic rate income tax band is reduced to 20% and the starting rate of income tax is abolished as outlined in Budget 2007.

During the year your employer will save £1,530.15 [calculated as a salary saving of (£40,000-£38,643.48) plus an NI saving of (£4,421.12-£4,247.49)] which can be paid as an extra contribution into your pension. In this example it equates to £127.51 each month. This means you have generated an extra £27.51 and you can still take away the same net salary of £28,351.60.

Salary sacrifice can also be used in a similar way to cover the cost of childcare and travel to work while saving tax and NI. But remember, like the pension scheme, they are reliant on your employer's willingness to participate.

Salary Sacrifice And Childcare

You can sacrifice some of your salary in return for childcare vouchers which could lead to savings of up to £1,196 per parent each year (depending on your circumstances). This benefit is non-taxable and exempt from NI contributions while also providing an NI saving for your employer at the same time.

Childcare vouchers are now a recognised way of covering the costs of childcare. All eligible working parents with children under 16 are entitled regardless of earnings. And this is a government scheme which is fully supported by HM Revenue & Customs (HMRC).

Salary Sacrifice And Travel

If you're prepared to swap your drive to work for pedal power you can get tax relief on the hire of a bicycle. Under this scheme you agree to reduce your salary temporarily to pay for the hire of your bike and cycling equipment until the end of the agreement. Again by taking a salary cut you will get relief from tax and NI as well as saving VAT, plus cycling is one of the cheapest ways to commute.

Here's an example of how this scheme works for a higher rate tax payer with a £500 bike package hired over a 12 month period which provides a generous saving of almost 50%:

• Bike package retail price (including VAT) £500
• VAT saved £74.47
• Income tax and NI saved £174.36
• Net monthly repayments £20.93
• Total bike package price £251.16

Source: Cyclescheme.

At the end of the rental period the bike can be sold by the employer to the employee based on its current market value.

Using salary sacrifice certainly seems like a win-win situation for everyone concerned but there are implications which you must take into consideration before entering into such an arrangement. For starters, salary sacrifice represents a contractual change to the terms and conditions of your employment so it isn't a decision to be taken lightly.

Here are some crucial factors you need to think about which may be affected by using salary sacrifice:

• Your future salary increases or bonuses, and benefits linked to salary such as death in service, overtime rates, holiday pay and so on. You need to check whether these will be related to your earnings pre- or post-salary sacrifice.
• Anything else which may be affected by your reduced salary such as your ability to get a mortgage or any other form of credit.
• If you're using salary sacrifice for childcare or travel, then check whether pension contributions made to your pension plan outside the arrangement will be based on your pre- or post-salary sacrifice earnings.
• Your entitlement to the State Pension and other benefits such as Statutory Sick Pay, Maternity and Paternity Pay could be impacted by a lower salary.
• Entitlement to any other means-tested benefits or tax credits including Working Tax Credit or Child Tax Credit may be affected if you have not paid sufficient NI contributions to qualify. Visit the HMRC website for further details.

Most other employee perks will be treated as taxable benefits and therefore can't be paid for tax-efficiently through salary sacrifice. At the moment you'll find pension contributions, childcare and travel are most commonly covered by the scheme. Unfortunately, your employer isn't obliged to offer any of these benefits, but remember there's certainly no harm in asking!