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Salary Sacrifice

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Salary sacrifice is basically a scheme in which employees sacrifice part of their salary to make contributions to a benefit, such as a group pension. This contribution then leads to a real-world uplift in value, thanks to savings made in tax and National Insurance.

Because these savings add up to a higher-value contribution, perception of the benefit improves, along with take-up rates.

Example of the benefits of salary exchange - £80 monthly net contribution

Scenario 1 - No salary exchange – basic rate taxpayer

The monthly pension contribution has basic rate tax (20%) added to it to achieve a gross contribution of £100 per month.

Scenario 2 – Salary exchange – basic rate taxpayer.

The employee sacrifices £115.94 of gross pay per month. This gross pay is worth £80 of net pay to the employee after deductions of basic rate tax (20%) and national insurance (11%).

The employer makes the monthly pension contribution of £115.94 plus the savings in Employers National Insurance it has achieved of £14.84 for a total contribution of £130.78. Thus the employee gains a 31% uplift in pension contributions.

Scenario 3 – Salary exchange – higher rate taxpayer

The employee sacrifices £135.59 of gross pay per month. This gross pay is worth £80 of net pay to the employee after deductions of higher rate tax (40%) and marginal rate national insurance (1%).

The employer makes the monthly pension contribution of £135.59 plus the savings in Employers National Insurance it has achieved of £17.36 for a total contribution of £152.95. Thus the employee gains a 53%1 uplift in pension contributions.

1 Note that higher rate taxpayers will be ceding their marginal rate tax recovery (the difference between the basic rate tax of 20% and higher rate tax of 40%) on personal pension contributions by opting for salary exchange.

For an employee earning £25,000, a contribution of 3% would cost £50 per month of net pay to achieve a £186 pension contribution!

Bonus Exchange

The option to exchange bonus payments for single pension contributions may also be offered to scheme members. This would benefit from the same uplifts in the value of the contribution.