In association withThe tax efficiency of salary sacrifice for different earnings groups seems to have been constantly under question as both former and current governments have grappled with the taxation of pensions.
But while the small print means some groups may now be better or worse off than they thought they might be six months ago, the overarching view is that salary sacrifice is here to stay, and will prove to be a valuable tool for advisers looking to manage the transition to auto-enrolment.
But for the corporate intermediary challenges remain in advising employer clients and employees where salary sacrifice will suit their needs and where it will not.
Salary sacrifice has always been dogged by the perception of not being the simplest of benefits. Since Labour’s 2009 Budget and then emergency Budget of the Coalition Government it has become more complex.
In essence salary sacrifice sees an employer allow a member of staff to offset part of their salary for a benefit provided by that employer. That benefit could be pension contributions, childcare vouchers or even a bike to cycle to work on. By providing this benefit the employer can then save on the National Insurance Contributions it pays on the employee’s salary because that salary is less than it was, while the employee pays for the benefit tax-free.
Labour announced its cap on higher rate tax relief for those earning £150,000 and over to come into force from 6 April 2011. The tax relief
To prevent individuals piling in for tax relief before the cut-off point the Labour Government also put in place the so-called anti-forestalling rules, by restricting, in the words of the HMRC guidance: “higher rate tax relief on pension contributions for individuals on incomes of £150,000 or higher that are in excess of their normal pattern prior to the new regime coming into effect.”
This to be done by “introducing a special annual allowance of £20,000 that applies from 22 April 2009 and an associated tax charge. Where an individual has taxable income of £150,000 or more, and increases their pension savings from 22 April 2009 beyond their normal regular amount then any additional pension savings may be subject to a special annual allowance charge.”
HMRC explains that the special annual allowance charge will have the effect of recovering the higher rate tax relief (but not basic rate tax relief) on certain additional pension savings. Any special annual allowance charge due will be paid through Self-Assessment.
However the coalition Government has suggested it will change the taxation limits again, consulting on bringing in a flat rate cap of £40,000 after which pension contributions won’t quality for tax relief.
Steve Herbert, head of benefit strategy at Jelf Group points out that it is not clear exactly what the Conservative-Liberal Alliance has in mind but he suspects if it is a flat rate contribution of around £40,000 that would probably be a big improvement on the Labour proposals. “But how they are going to deal with salary sacrifice around that is not entirely clear,” says Herbert. “My personal view is that something much the same as what very high earners over £150k faced last year will apply to the people saving more than £40,000. So ultimately it will make salary sacrifice slightly less attractive for a very small percentage of the population. But frankly it won’t be a big deal.”
Danny Cox, pensions development manager at Hargreaves Lansdown believes the numbers of firms and individuals using salary sacrifice will continue to increase, as will ultimately, levels of pension savings across the board.
“National insurance contributions are due to rise and salary sacrifice is one of the best ways to combine employee benefits with tax savings,” he says. “The new pension contribution cap will limit the average payment. But I would expect, when combined with the other proposed changes to pensions, there will be a marked increase to the amounts paid into pensions.”
In addition it will change the way many individual save for their retirement, encouraging regular saving early rather than large saving late, he adds.
“Current thinking is that this cap will include individual and employer contributions,” explains Andrew Reeves, director of The Investment Coach. “Therefore it will have an impact certainly on pension planning and some will see it as the target. It won’t be possible to do a last minute splurge to boost the pension. So a more consistent contribution record will be important. Salary sacrifice will continue to be the best route to accrue a retirement pot particularly if the employer fully rebates their National Insurance saving. The forthcoming National Insurance Contribution rise will further improve the relative benefits of salary sacrifice.”
Corporate advisers need to consider how their employer and employee clients should tread, especially in light of the anti-forestalling rules.
Robert Lockie, investment manager and branch principal at Bloomsbury Financial Planning says while the anti-forestalling rules remain in place, so currently one must comply with those as it seems likely that they may well do so until April 2011, when they would have become irrelevant anyway.
“In the meantime, given the pressure on the public finances, it would be wise for investors to make use of existing exemptions and allowances while they can, subject of course to not subordinating considerations of what is required to achieve their goals and how much risk they are willing to take to achieve them to the tax issues,” he says. “It’s not much good buying a tax-efficient asset with a ten-year fixed term if you expect to need the money in five years.”
Lockie adds that it is worth remembering that the new measures introduced in the last few years actually don’t impact on a huge percentage of the population as most have taxable income of under £130,000, so will not be caught by the anti-forestalling provisions. But that obviously that proportion will rise if the limits are not raised in future however.
Herbert believes it is important that employers bear in mind the real benefit of salary sacrifice. “Salary sacrifice is a way of making a pension scheme better without adding to the costs but it shouldn’t be a way of mitigating employer’s costs,” he says. “It is about getting the best tax savings for the employee really.”
Which is why many advisers see it as core to their auto-enrolment advice packages.
Will salary sacrifice be the saviour of employees when auto-enrolment comes in?
Harvey Perkins, associate partner at KPMG says: “Starting from 1 October 2012, the roll-out of automatic enrolment will mean all employees will be signed up into an employer’s pension scheme. For many employers, this may mean a considerable increase in employment costs as there is a mandatory requirement for the employer to make a contribution to the employee’s pension – 3 per cent by 2017. However, salary sacrifice is a tool that employers can use to reduce the impact of these cost increases. The National Insurance savings made by an employer using salary sacrifice for the employee’s contributions will not go as far as covering the cost increases incurred by the introduction of this legislation, but they will go some way to reducing the level of increase, especially if employees are encouraged to contribute higher levels than the statutory minimum.
“There is always a risk that some employees can be negatively affected by salary sacrifice arrangements, such as those on low incomes and those close to retirement. As such, careful analysis of a workforce is needed prior to the implementation of any scheme of this nature and the option must be provided for employees to opt out of the salary sacrifice arrangement.”
Salary Sacrifice impact on pension savings
David Heaton, tax partner at Baker Tilly explains: “If the basic rate tax payer swapped his pension contribution and the employer put all their NI savings into the pension fund, the employer’s pension contribution would be £1,585. The salary is only reduced by £1,405 because there is an employee’s NI contribution which can be taken into account as well (because by reducing his pay he reduces his NI and the employer reduces his NI). So £1,405 is the employee’s salary sacrifice. In effect the employee is £365 better off and the employer is only paying a £1 more.
“For the 40 per cent tax payer earning £112,950, by dropping his pay to £101,365 and not making a pension contribution through opting for salary sacrifice, then the income tax changes slightly because the amount he is getting in pension contribution from the employer is slightly more the original pension contribution of £11,295 the employee could have paid. The income tax and NI costs go down because the contractual pay has gone down. The net spendable pay is £65,843, so pretty much the same but with £13,068 in the pension fund instead of £11, 295. So the employee is £1,772 better off with salary sacrifice and the cost to the employer is the same as when the employee was paying the contribution. Finally, for the 50 per cent tax payer earning £200,000, the effect of the salary sacrifice is that instead of swapping the straight £20,000 you can actually swap slightly more. The net pay goes down to £179,592 because the employee is saving a 1 per cent NI contribution by switching to allow an employer pension contribution. Net spendable is the same at £106, 721 but the employer pension contribution is £23,020.
“This employee is caught by Alistair Darling’s pension contribution rules. Those in the 50 per cent tax band would only get 20 per cent relief on their pensions – so in this case the contribution is slightly more that the threshold of £20,000. He can only get 20 per cent tax relief on the £3,020 he has ’oversaved’. That tax relief is £906 which in the employee must declare in his self assessment tax return.”
