Salary sacrifice or direct pension contributions?

It has become increasingly common for employees to sacrifice part of their salary and/or bonus in exchange for their employer contributing the sacrificed amount to their pension on their behalf.

This approach can be more advantageous than making direct pension contributions, particularly if the employer adds their National Insurance (NI) contribution savings to the pension.

Benefits of Salary Sacrifice

Contributions from an employee’s post-tax pay are less attractive because both the employee and employer will have already paid NI contributions on the gross income. However, if the employee arranges to sacrifice salary/bonus equivalent to the desired pension contribution, the following advantages arise when that amount is paid as an employer contribution:

• 20% Taxpayer: The pension contribution can increase by 26.4%, assuming the full employer’s NI savings are added to the member’s scheme.
• 40% Taxpayer: The pension contribution can increase by 17.7%, with the full employer’s NI savings applied.
• 45% Taxpayer: The pension contribution can increase by 18.05%, given the full employer’s NI savings are utilized.
• High Income Child Benefit Charge: This sacrifice can help reduce or eliminate the charge on income above ￡60,000.
• Reclaim Personal Allowance: For incomes between ￡100,000 and ￡125,140, salary sacrifice can help reclaim the personal allowance along with tax and NI savings.
• Immediate Tax Relief: Unlike direct contributions to a personal pension scheme, where higher or additional rate relief must be claimed via self-assessment, employer contributions typically provide immediate full tax relief.

In the 2024/25 tax year, the primary threshold for Class 1 National Insurance contributions was ￡242 a week (equivalent to ￡12,570 annually), consistent with the 2023/24 tax year.

Conditions for Effective Salary Sacrifice

To be effective, salary sacrifice must comply with HMRC’s Employment Income Manual criteria. It must be made before the remuneration being sacrificed is treated as received for employment income tax purposes.

For employees, this typically means the earlier of:

• The date the payment is made, or
• The date the individual becomes entitled to the payment.

For company directors, additional considerations include:

• The date when remuneration is credited in the company’s accounts,
• The end of the company’s accounting year if the remuneration is determined during that period, or
• The date the amount is determined if it is set after the relevant period.

If there is uncertainty regarding when a director’s remuneration becomes assessable, it should be confirmed by the company or the director’s accountant.

Additional Considerations

When evaluating a salary sacrifice, employees should consider the potential impact on other benefits. For instance, if part of an occupational pension scheme or a group life scheme, a reduced salary could decrease these benefits unless the employer continues to base them on the pre-sacrifice salary.

A reduced salary might also affect mortgage loan eligibility. Lower-paid employees should ensure their salary does not fall below the national minimum wage. However, they might benefit from higher tax credits due to a reduced salary.