Salary Sacrifice Pension Contributions
The Contractor Co-op offers contractors the opportunity to make pension contributions by way of salary sacrifice. This relates to both the workplace pension we operate with The People’s Pension and to contributions to personal pension schemes.
Salary sacrifice is an agreement between you and your employer whereby you exchange part of your gross salary or bonus entitlement in return for a non-cash benefit - in this case a pension contribution.
With typical pension arrangements, you make contributions direct to your pension plan from your take home pay. With salary sacrifice, however, your gross salary is reduced by the amount you choose to exchange and this amount is paid into your pension as an employer contribution. As a result of making your pension contribution by way of salary sacrifice you will not pay NICs on the amounts contributed to your pension scheme.
Salary sacrifice is a tax efficient way
for you to make pension contributions
Background to salary sacrifice
With effect from 6th April 2017, the provision of benefits in kind by way of salary sacrifice arrangements was largely withdrawn. One of the few benefits to survive these changes was employer contributions into a registered pension scheme for the employee’s benefit and employer provided pensions.
Salary sacrifice is a contractual agreement between you and your employer as a result of which you agree to waive part of your salary, either a fixed amount or a percentage of monthly income, in exchange for the employer pension contribution. This must be an ongoing arrangement and you will be asked to sign an agreement which will be effective for a minimum period of 12 months unless you experience a significant ‘lifestyle change’ such that the arrangement is no longer suitable. Examples of a significant ‘lifestyle change’ would include:
the redundancy of a partner,
the pregnancy of the employee or his or her partner,
the death of a partner, or
the employee's marriage or divorce.
Limits on pension contributions
There is currently an annual limit on pension contributions of £40,000 in a given tax year. Unused allowances from the previous three tax years can be carried forward, however, the current year’s allowance will always be used first. A lifetime allowance of £1,055,000 also applies.
The £40,000 annual allowance will be reduced if:
1. You have already accessed your pension benefits, in which case a limit of £4,000 will apply;
2. Your ‘threshold income’ is over £110,000 and your ‘adjusted income’ is over £150,000. In this scenario, your annual allowance will be reduced by £1 for every £2 by which your ‘adjusted income’ exceeds £150,000 – this is known as the tapered annual allowance.
If your ‘threshold income’ is £110,000 or less, you cannot be subject to the tapered annual allowance. Broadly speaking, ‘threshold income’ is defined as your net income for the year and will include taxable income such as the following elements, reduced by the amount of any taxable lump sum pension death benefits you receive during the tax year.
pension income (including state pension),
taxable element of redundancy payments,
taxable social security payments,
income from property (rental income),
onshore and offshore bond gains,
taxable payment from a Purchased Life Annuity,
interest from savings accounts held with banks, building societies, NS&I and Credit Unions,
interest distributions from authorised unit trusts and open-ended investment companies,
profit on government or company bonds which are issued at a discount or repayable at a premium and
income from certain alternative finance arrangements etc.
Only if such income exceeds £110,000 do you need to consider your ‘adjusted income’, which in basic terms is your threshold income plus your salary sacrifice pension contributions.
This is clearly a complex area and if you have any doubts regarding your personal annual pension contribution allowance you should seek professional advice from your investment advisor.
Background to salary sacrifice
The benefits in terms of increased extraction from contract income can be clearly seen from the following summary monthly pay projections:
Other factors to consider
As can be clearly seen from the examples above, making pension contributions by way of salary sacrifice can increase your income extraction. The fact that there is, however, a sacrifice of cash income must not be overlooked. Given that this is a commitment which will continue for a minimum period of one year, you must be sure that the contributions you agreed to are affordable and that your reduced salary will not impact on other financial matters, for example mortgage applications, life assurance, income protection etc.
What to do next
If you are interested in finding out more about how you could benefit from salary sacrifice pension contributions, please get in touch. We would be happy to discuss your options with you and provide pay projections so that you can see exactly how your personal situation would be affected.
Call us today to find out how you can become part of The Contractor Co-op