The simple move that can boost your pension pot by £43,000

The old adage ‘if it’s too good to be true, it probably is’ almost always applies

when it comes to money. Unbelievable deals and discounts frequently turn out to be scams or not what they first seem.

But there is one exception.

Salary sacrifice is a simple, effort-free money hack that could boost your income, increase your pension by £43,000 – and even help with childcare costs.

Plus, it could assist your employer with the rise in National Insurance that comes into force in April, signalled by Chancellor Rachel Reeves in last year’s Budget.

Implausible as it may sound, salary sacrifice can achieve all this without costing you or your employer a penny. And a couple of emails are all it probably takes to sign up.

Tax free: With a salary sacrifice scheme, contributions attract neither income tax nor National Insurance. That amounts to a saving for you and your employer

When the scheme offers so many advantages, you may wonder why more people don’t use it. Susan Hope, retirement expert at pension firm Scottish Widows, says lack of awareness is one reason. 

Up to 22 per cent of workers have never heard of it and only 18 per cent say they’re enrolled with their employer, a survey for the firm found.

‘While salary sacrifice – sometimes known as “salary exchange” – might sound complex, it’s just a slightly different way to make pension contributions,’ she says. 

‘Importantly, it never results in people taking home less pay. but lack of awareness means a lot of people are missing out on essentially free money that could be boosting their pension savings.’

Matt Haswell, pension consultancy director at wealth management firm Evelyn Partners, adds: ‘It is quite probable many people are working for firms where salary sacrifice is an option for pensions, but they aren’t aware of it.’

However, salary sacrifice is not always a slam dunk, as it can leave some workers worse off.

Here, Money Mail looks at how much it could save you – and your employer – and how to work out if it’s right for you.

How salary sacrifice works

Although called ‘salary sacrifice’, no sacrifice is required by you – or your employer.

It works like this. Normally with a workplace pension, you pay in a proportion of your salary. Your employer pays in, too.

With salary sacrifice, your salary is reduced by the amount you pay into your pension. Then your employer puts that money directly into the pension.

From your perspective, this is little more than an accounting quirk. Your take-home pay is unchanged and you end up with the same amount in your pension.

But doing it this way has several key advantages.

The first is that your pension contributions are not subject to National Insurance (NI). Under a conventional scheme, income tax is not paid on contributions, but you and your employer pay NI on them.

With a salary sacrifice scheme, contributions attract neither income tax nor NI. That amounts to a saving for both you and your employer.

Say, for example, you are earning a salary of £35,000 and paying 5 pc into your pension, while your employer contributes 3 pc. Under a conventional pension scheme, that would mean you paid in £1,750 a year and your employer £1,050 – a total of £2,800.

If you opted for salary sacrifice, your employer would put the full £2,800 straight into your pension – including the £1,750 that you would have made if you were in a conventional scheme.

In return for making that payment in your place, it cuts your salary by the same amount, meaning on paper your salary becomes £33,250 (£35,000 minus £1,750). Your take-home pay is unaffected and you end up with the same amount in your pension.

Here’s the clever bit. Because the contribution is put straight into your pension, it does not attract NI.

You would have paid NI on your £1,750 pension contributions at 8 pc – a total of £140. Your employer would have paid NI on it at 13.8 pc – going up to 15 pc from April 6 this year – a total of £242 at the current rate, according to Scottish Widows.

The savings you both make can be used in a couple of ways. One is to hand your NI savings back to you – so you would take home an extra £140 a year – and your employer pockets its £242 saving.

Or your employer could put all of the NI savings you both have made into your pension. Doing this means that its contribution also benefits from tax relief, bringing the total up to £463.

If this is added to your pension, it would increase the size of your pot by £19,100 over 25 years, assuming it grows at 5 pc, according to Scottish Widows.

For someone on a salary of £105,000 a year, that would amount to an extra £42,900 in their pension pot over 25 years.

Retirement boost: With salary sacrifice, your salary is reduced by the amount you pay into your pension. Then, your employer puts that money directly into the pension

Why it can boost parents…

Salary sacrifice can also be used to cut the cost of childcare. This is because if a household has one parent earning more than £60,000, they start to lose eligibility for child benefit.

 It tapers until someone earning above £80,000 gets no child benefit at all. But salary sacrifice can make it appear on paper as if your salary is lower than it actually is. That could bump up your eligibility.

…and help savers, too

Basic-rate taxpayers can earn up to £1,000 interest a year tax free, while higher-rate taxpayers have a £500 allowance. Additional rate taxpayers have none at all.

If your income is just above the threshold of a tax bracket, you may be able to use salary sacrifice to bring it below the cut-off point.

For example, someone on a £50,270 salary will be a higher-rate taxpayer with a personal savings allowance of £500. 

But, if using salary sacrifice on pension contributions of 5 per cent, their salary would drop to £47,756. As a result, they would become a basic-rate taxpayer and their personal savings allowance would double to £1,000.

Times when you shouldn’t use it

some benefits are only available to those on a minimum salary. Therefore, if salary sacrifice would bring you below that minimum, you shouldn’t go for it.

Mike Ambery, retirement savings director at pension firm Standard Life, explains: ‘Salary sacrifice is tax and National Insurance-efficient for pensions, but may not always be right for you.

‘The lower salary can impact items such as Statutory Maternity Pay. You’ll need to check if salary sacrifice suits your individual circumstances.’

Employers cannot offer salary sacrifice if it takes your salary to below the minimum wage – £11.44 for employees over the age of 23.

And be careful if you’re applying for a mortgage which takes your headline salary into consideration when deciding how much you can afford to borrow.

Brokers and lenders should know about salary sacrifice and know your income has not really dropped even if it looks like it has. But there’s no guarantee.

How it benefits your employer

The NI savings that salary sacrifice offers to employers will become even more valuable when the rate they pay rises from 13.8 per cent to 15 per cent from the new tax year.

The changes to employer NI contributions are forecast to raise between £23.8 billion and £25.7 billion a year, for the next five years.

Gary Smith, of Evelyn Partners, says: ‘Salary sacrifice can be a win-win for employees and employers, but despite the financial benefits many organisations still do not operate such a scheme.’

He calculates that if an employer had a wage bill of £1 million on which NI was payable, they would get a £138,000 tax bill this year, and £150,000 when the rate rises.

In a normal workplace pension, a total of £50,000 would be paid in by employees paying 5 per cent of salary. If the employer converted the scheme to salary sacrifice, the wage bill would drop to £950,000 and the NI would drop to £142,500, a saving to the employer of £7,500.

Where you can sign up

You may find you are in a salary sacrifice scheme already –although 40 per cent of employers do not offer them, according to pension provider Aon. If you’re in one, your pension contributions will appear on your wage slip as £0 and those of your employer will be their contributions and what you are paying in combined.

Mike Ambery, at Standard Life, adds: ‘If your employer offers one, it tends to offer it as a default, although if it changes to salary sacrifice it will have to notify you as technically it involves a change to your work contract. You should be able to opt out though.’

If you are not in a salary sacrifice scheme, you can ask your employer if it offers one. And if not, you can suggest your employer begins to – the benefits will only increase for both of you.