Why big savings could be made by giving up some of your salary

The top rate of income tax increased from 40 per cent to 50 per cent on 6 April for those earning more than £150,000, while the personal allowance will be gradually withdrawn for those earning more than £100,000 and from April 2011 National Insurance contributions (NICs) rise from 11 per cent to 12 per cent.

 

If appropriate to your particular situation, participating in a salary sacrifice scheme could reduce your taxable income. A salary sacrifice scheme brings down your taxable pay in return for other benefits, so it could help you avoid paying the highest rate of tax. For big public sector employers, it is also a way to give a pay rise.

The most common form of salary sacrifice is to make pension contributions out of your pre-tax earnings. You do not have to pay NICs on contributions and if you can bring your pre-tax income down to a lower band, you will save income tax as well. Most big companies offer pension schemes that save employees tax but not NICs.

From 6 April, someone earning £160,000 will now pay £62,880 in income tax and NICs with no pension contribution. However, if you contributed £16,000, you could bring down your taxable income to £144,000, and pay tax and NICs of £55,320 instead. You would avoid 50 per cent tax on £10,000 of the contribution and 40 per cent tax on the other £6,000, a total tax saving of £7,400 according to figures from Standard Life, the insurer.

You would also reduce NICs by £160 (you pay NICs at 1 per cent on earnings above £43,888). Your employer also saves NICs. If you had earned £16,000 as salary, your employer would have paid NICs at 12.8 per cent, or £2,048. This will instead go into your pension.

The reduction in salary would not have the same effect as asking the employer to make the contributions on the employee’s behalf. An employee’s cash salary will be permanently reduced and replaced with the pension benefit. Before taking out salary sacrifice, employees should consider the effect this may have on:

- their ability to borrow money, for example for a mortgage
- the amount that can be contributed to their pension plans, or pension plan if they are taken
- their entitlement to redundancy payments, and National Insurance Rebates, State Pensions or other benefits such as Statutory Maternity Pay, working Tax Credit or Child Tax Credit

This may also affect other policies held, such as some forms of income protection.