Claiming Tax Relief with Salary Sacrifice Pensions

UK pensions have become pretty complicated to understand, due to frequent changes in legislation and the sheer number of schemes now available. Each change has meant more work for most businesses, not to mention the added cost of implementation and administration that comes with a pension scheme.

The introduction of auto enrolment also means more people are now saving towards a pension to protect their future retirement. When saving into a pension, most people (unless they earn under the personal allowance and are a non-taxpayer) will get their fund topped up in the form of tax relief on their contributions. This depends on the type of scheme you’ve signed up to, but basic rate taxpayers get 20% pension tax relief, higher rate payers get 40% pension tax relief, and additional rate taxpayers get 45% pension tax relief.

Unfortunately, higher rate taxpayers need to apply to HMRC to claim their additional 20%-25% or request a revised tax code. Which means that although this tax relief is available, many higher earners are ending up out of pocket due to failing to claim their additional tax relief owed. But this doesn't need to be the case...

Net Pay Arrangement or Relief at Source?

If you want to offer your employees tax relief on their pensions, you can choose either a Net Pay Arrangement or a Relief at Source method of deduction into an employee’s pension. If you operate a Net Pay Arrangement then tax relief will be given on the pension contribution via the payroll. This means that the employee won’t need to provide details of pension contributions on their self-assessment tax return to get their tax relief. It will already be applied, which avoids the need to reclaim addition tax relief from HMRC.

If you operate a Relief at Source arrangement, employers take 80% of an individual’s pension contribution from their income after tax has been deducted. The tax relief is then reclaimed from HMRC by the pension scheme provider but HMRC will only top up the pension scheme with the basic rate of tax at 20%. Employees who are higher or additional-rate taxpayers must make a claim on their tax return to receive the additional tax relief due.

Introducing Salary Sacrifice pensions

An alternative to the above is a salary sacrifice (or ‘salary exchange’ pension). This type of arrangement means that the employee agrees to sacrifice some of their potential earnings in exchange for higher pension contributions. Whilst there are complexities that come with the contractual obligations of salary sacrifice, once set up the additional benefit to both employer and employee are well worth the time.

This is because a salary sacrifice pension can save both the employer and employee National Insurance contributions in addition to ensuring tax relief is given automatically. This type of agreement means giving up part of your salary in return for a bigger contribution to your pension pot. It is one of the most common ways to boost pension contributions.

As an example, if an employee’s salary is £30,000 and they sacrifice £1,500, their salary will be £28,500. This is now the amount that is subject to tax and National Insurance, making a saving of £480 plus receiving the additional £1,500 in thier pension pot.

With a salary sacrifice scheme, there is no additional tax relief to claim because the employee has been taxed on a lower amount of salary already. As you sacrifice some of your salary to go into your pension and therefore receive less gross pay, both the employer and employee will pay less National Insurance. Employers may then choose to pay part or all of this NIC saving into the employee’s pension, or could even choose to use the money to help cover costs of auto enrolment implementation.

Salary sacrifice is a tax-efficient way to boost employees’ pension and, alongside regular contributions, it can be the best way to maximize your pension pot. With minimum employee contributions rising from 5% to 8% back in April 2019, employees could suffer a significant loss if they are not claiming their additional tax relief.

Other considerations of salary sacrifice pensions

It’s important to explain to an employee how salary sacrifice can impact other aspects of their finances. Here are a few considerations that you’ll need to be aware of before opting for a salary sacrifice pension:

• A reduction in salary will reduce the level of income tax and NIC your employee will have to pay.
• Salary sacrifice is not available if it reduces earnings under the minimum wage.
• Entitlements to state benefits such as Statutory Maternity Pay, and the State Pension will be affected if salary falls below the level you pay National Insurance Contributions on.
• Some means-tested benefits such as working tax credits will be awarded based on the lower salary, therefore possibly meaning a higher reward.
• Lower borrowing may be available on mortgages due to the reduced salary.

As you can see there are a variety of pros and cons to consider. For example, if you are thinking of having children in the near future your maternity pay may be affected negatively. However, if you rely on working tax credits, your reward may be higher if you agree to a salary sacrifice pension. As such, it's important to carefully weigh up the pros and cons before deciding on the best option for your business and employees.

About the Author

James Alesbury MCIPPdip is the Director and Specialist in Payroll and Auto Enrolment for the SME market at HWB Chartered Accountants. James has a background in accountancy, payroll and human resources, becoming a full member of the Chartered Institute of Payroll Professionals (CIPP) in 2008. He has worked within a variety of sectors for companies such as Hampshire County Council, Matchtech Group PLC, Solvay Pharmaceuticals Ltd and B&Q PLC.