Increases to National Insurance Contributions (NICs) from next April have made employee pension contributions less attractive.
That headline is not one you might expect to see from a financial adviser, but there is some solid logic behind it. Consider Jane who earns £40,000 a year and makes net contributions to her employer’s workplace pension of £2,000 annually (equivalent to £2,500 once basic rate tax relief is included):
To earn £2,000 net, Jane must receive £2,941.18 of gross pay:
- Gross pay £2,941.18
- Employee NICs @ 12% (£352.94)
- Income tax @ 20% (£588.24)
- Net pay £2,000.00
In addition, Jane’s employer will have to pay 13.8% National Insurance Contributions (NICs) on her gross pay – another £405.88.
So, the total cost of putting £2,500 into Jane’s pension is £3,347.06.
The alternative is for Jane and her employer to agree to a salary sacrifice arrangement under which she forgoes £2,941.18 of salary and in return has £3,347.06 paid into her pension by her employer – a gain of 33.9% compared to paying personal contributions. In practice, the benefit may be slightly less as some employers levy an administration charge for salary sacrifice arrangements and pay only a certain percentage of the employer NIC saving.
From April 2022, when NIC rates rise by 1.25% for employer and employee, Jane’s potential gain increases to a maximum of 37.9%.
In this instance, higher rate taxpayers gain less because their marginal NIC rate will normally be less (2% in 2021/22, rising to 3.25% from 2022/23). Do the math and the benefit is 17.7% in this tax year and 21.6% thereafter (the figures in Scotland are marginally higher because its higher rate is 41% rather than 40%).
Despite the obvious appeal of the option, if your employer offers salary sacrifice for pension contributions, you should always seek financial advice before agreeing to a sacrifice arrangement. There can be disadvantages to salary sacrifice stemming from lower gross pay. If your employer does not offer salary sacrifice, then you may want to ask why…
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