If you are a high-earning PAYE employee and looking to reduce your tax liability, you may want to consider a salary sacrifice scheme. By giving up some of your earnings in exchange for higher pension contributions, you may be able to bring your tax bill down while simultaneously boosting your retirement savings.
In this guide, we are going to look at how salary sacrifice and pensions tax relief works and the potential benefits for high earners. We’ll also highlight some issues to be aware of and explain why this financial planning strategy is not suited to everyone.
What is salary sacrifice and how does it impact tax?Â
Also known as a ‘salary exchange’, a salary sacrifice is an agreement between you and your employer to reduce your salary in exchange for a non-cash benefit. Non-cash benefits can include childcare, healthcare, transport, or increased pension contributions.
If you choose to go with increased pension contributions, your employer will reduce your salary and then pay the difference between your original salary and your new salary into your pension. This will result in a lower taxable income for you along with tax-efficient contributions into your pension account.
The power of pensions
Before discussing the benefits of a salary sacrifice and pension tax relief, it’s worth touching on the advantages of contributing to a pension.
In the UK, investing within a pension remains one of the best ways to build wealth for retirement. Inside a pension, capital can grow free of Income Tax and Capital Gains Tax (CGT).
A pension can also be a very effective estate planning tool. That is due to the fact that money in a pension is generally not subject to Inheritance Tax (IHT).
Given their tax advantages, pensions can be very powerful vehicles for building and preserving wealth. When it comes to long-term financial planning, they shouldn’t be ignored.
The benefits of salary sacrifice
As for the benefits of setting up a pension salary sacrifice scheme, there are quite a few if you’re a high earner.
For a start, you’ll pay less Income Tax as your taxable income will be lower. You’ll also pay lower National Insurance contributions (NICs).
Next, you can boost your retirement savings tax-efficiently. By making pension contributions directly from your pre-tax income – instead of from your salary after Income Tax and National Insurance have been deducted – you can potentially accelerate your pension’s growth. It’s worth noting here that tax relief is instant, which might be appealing if you’re a high earner, as you won’t need to claim higher-rate tax relief through self-assessment.
You also have flexibility with your pension contributions. Usually, salary sacrifice schemes are quite flexible (depending on your employer), allowing you to adjust your contributions as your circumstances change. This enables you to optimise your retirement planning based on your evolving needs and goals.
Salary sacrifice and pension tax relief issues for higher earners to considerÂ
While a salary sacrifice arrangement can be a very effective tax planning strategy, there are some issues to be aware of.
One is annual pension allowances. If your employer makes contributions to your pension account via salary sacrifice, the immediate tax relief you receive could take you over the annual allowance (which is usually £60,000 per year or 100% of your salary – whichever is lower). This could result in an unexpected bill from HMRC. It’s therefore very important to understand exactly how much of your income you are sacrificing.
Related to this issue is the tapered annual allowance. If you have an ‘adjusted income’ of more than £260,000 per year and a ‘threshold income’ of more than £200,000 per year, your annual pension allowance will be tapered. In this scenario, personal pension contributions may be more effective than a salary sacrifice as they will reduce your threshold income and if reduced to £200,000 or less the tapered allowance can be avoided.
Reducing your salary via salary sacrifice could also lower the amount you’re able to borrow for a mortgage or reduce the amount of life insurance you’re able to obtain. Given all these complex issues, it’s a good idea to speak to a financial adviser before committing to a salary sacrifice scheme to see if it’s the right approach for you.
What is a bonus sacrifice?
If you typically receive substantial bonuses as part of your remuneration package, you could also consider a ‘bonus sacrifice’. With a bonus sacrifice, your bonus is paid directly into your pension instead of being paid into your bank account. You then don’t have to pay any Income Tax or National Insurance on it.
Again though, it’s important to have a good understanding of how much you are contributing to your pension and your annual allowance. With this strategy, bonuses will only be tax-free if the rest of the year’s pension contributions are under the annual pension contribution limit.
How Bowmore can help
Setting up a salary sacrifice arrangement can be an effective way to maximise your retirement savings and reduce your tax liabilities. However, while a salary sacrifice is often a smart financial planning strategy for high earners, it’s not going to be the best approach for everyone. As always, it’s a good idea to speak to an expert before making any moves.
At Bowmore, we have decades of experience when it comes to helping high earners minimise their tax liabilities and build wealth for retirement. We understand the challenges you face, and we can help you navigate them.
If you would like to learn more about how we can help you with your financial planning needs, get in touch.
- Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority
- The Financial Conduct Authority does not regulate Estate Planning or Inheritance Tax Planning.
- Bowmore Financial Planning Ltd is not regulated to provide tax advice.
- A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.
