A sacrifice worth making

If your employer were to ask you to take a cut in pay, most parents might reasonably think that someone had parted company with their senses. Yet it could be the best decision you ever make, should you agree.

Of course, nothing is what it seems. When we talk about a pay cut, we are really looking at sacrificing part of your salary in return for something really worthwhile. In this case, a pension contribution.

Pensions are all very worth while, but they are a little bit remote, for most of us. So why should we consider giving up income now, for a better long-term future?

Well, of course, the simple answer is that if you do not plan for a pension yourself, you will have to rely on the state. And with the current basic state pension standing at just £90.70 a week for a single person (£145.05 a week for a married couple), a person earning £48,000 a year could face a 84% drop in income (at best) if they have no other provision (although the second state pension should provide some additional income).

There is an immediate benefit. Every pound you put into a pension now saves you 20p in tax immediately (actually you only have to pay 80p in the pound, the government adds the other 20p to your pension scheme for you), and an extra 20p for higher rate taxpayers via the self assessment system. There are limits to how much you can invest which are broadly the lower of your annual income from trade profession or employment and the annual allowance which is £235,000 for 2008/9. (But even non-earners can put in £2,880 and have this rounded up to £3,600 by the taxman.)

But if you allow your employer to make the investment on your behalf instead of part of your salary (it does not cost him a penny, because pension contributions, like salaries are a tax allowable expense) there are extra benefits to you both.

You will save on both tax and national insurance contributions and your employer can save 12.8% of your salary in national insurance contributions, as well – which can also be put into your pension without any tax liability, provided the annual allowance is not exceeded and the total contributions are justified in terms of a business allowance.

In practice this means that a person earning £48,000 a year, who decides to ‘sacrifice’ £5,000 a year into pension contributions would actually only give up £2,950 a year in income. If the employer were to add the national insurance saving to the sacrificed salary, the total contribution might be £5,640 a year. The employer has no additional cost, but the employee has a significant pension pot building up.

There are, of course some rules applying to salary sacrifice arrangements, because the contractual right to cash pay must be reduced. For this to happen:

• the potential future remuneration must be given up before it is treated as received for tax or national insurance contribution purposes; and
• the revised contractual arrangement between employer and employee must be that the employee is entitled to lower cash remuneration and a benefit.

You should consider carefully the effect, or potential effect, that a reduction in your pay may have on:

• Future right to the original (higher) cash salary;
• Entitlement to Working Tax Credit or Child Tax Credit;
• Entitlement to State Pension or other benefits such as Statutory Maternity Pay.

If you require any further information about the services that we provide or would like to review your financial planning position, please contact us

Articles