Advantages for the employee
Taking the example above, by reducing their salary, the employee will no longer pay NIC (or the future Health and Social Care levy) on the amount of salary they exchange. So, in comparison to their previous position, they’ll experience an increase in net pay, as they now pay less NIC. From April 2022 the saving in NIC (and the subsequent H&SC levy) will be between 13.25% and 3.25% of the sacrificed amount, depending on earnings (see table below).
Full and immediate tax relief for higher rate tax-payers
Employee contributions into contract-based pension schemes, which include Group Personal Pensions, operate on a ‘Relief at Source’ tax relief basis. Under this arrangement, 80% of the gross contribution is deducted from the employee’s net pay. Basic rate relief of 20% is then added to the pension by HMRC, irrespective of the employee’s income tax rate.
Therefore, basic rate tax-payers automatically obtain full tax relief, but it’s not as simple for higher rate tax-payers. They’re eligible for further tax relief which can be claimed through their self-assessment return or by altering their tax code with HMRC. Normally this means there’s a delay in obtaining the relief, and they face the burden of completing a tax return, sometimes solely to claim the rebate.
Under salary sacrifice, there are no employee pension contributions as all payments become employer contributions. As such, this issue doesn’t arise. Every employee receives the equivalent of their full tax relief each month.
It’s important to note that trust-based pension schemes, which include Master Trusts like NEST, can operate on a ‘Net Pay’ basis. This method applies full pension tax relief through the payroll, so the advantage of salary exchange for these members is solely the saving in employee NIC.