Why you should use a salary sacrifice scheme to save more into your pension

Salary sacrifice schemes can be a valuable perk when you are building up a pension, says David Prosser.

Boy swinging on playground bars
These schemes can apply to childcare vouchers too
(Image credit: © Getty Images)

Are you missing out on a valuable pensions tax perk that could save you hundreds of pounds? Research from Mercer, a consultant, suggests that a fifth of employees are failing to sign up for salary-sacrifice arrangements, even though these could be a more tax-efficient way to save for retirement.

In a traditional occupational-pension scheme, you make contributions to your savings out of your pay, claiming income-tax relief at your highest marginal rate of tax – up to 45% for the highest earners.

Salary-sacrifice schemes offer exactly the same tax relief, but require you to forego the proportion of your salary you would have paid into the pension scheme; instead, your employer then covers the cost of your contribution.

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Exactly the same amount of cash ends up in your pension scheme either way, but the latter arrangement has one big advantage: there will be no national insurance contributions to pay on the salary you’ve sacrificed – that’s a saving of up to 13.25% on this cash. Your employer also makes a saving, since it doesn’t have to pay employers’ national insurance on this money. Normally, its contribution is 15.05% of salary.

These are valuable perks. Mercer says someone earning £40,000 a year and paying 6% of pay into their pension scheme would save £318 in national insurance contributions annually in a salary-sacrifice set-up. Their employer would save an additional £361 each year.

Not all employers currently offer salary-sacrifice arrangements, but given the tax advantages to them of doing so, take-up is increasing. The schemes don’t have to be used only for pensions. Other non-cash benefits, such as childcare vouchers, can also be offered in this way.

The two key downsides to salary sacrifice schemes

There are some potential disadvantages for employees to consider. By joining a salary-sacrifice scheme, you are lowering your salary. You’re not losing out financially because the reduction is only what you would have paid into your pension scheme, but the lower figure is the one that will be used for other important calculations.

One example is your life insurance. Many employers offer death-in-service benefits to the value of a multiple of your salary, so a lower salary means you’ll qualify for less cover. Your entitlement to certain state benefits, such as statutory maternity pay, could be reduced for the same reason.

Similarly, if you plan to apply for a mortgage in the near future, remember that banks and building societies will decide how much they are prepared to lend you partly on the basis of your earnings. So a reduced salary could decrease the size of the mortgage you can secure.

These considerations aside, however, salary-sacrifice schemes offer a good deal for the majority of employees given the national-insurance saving. If you have the option of joining such an arrangement, think hard before saying no – and if your employer doesn’t currently offer salary-sacrifice, it’s worth pointing out the tax advantages to them of putting one in place.

David Prosser
Business Columnist

David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.