AT the time of writing, the new Conservative/Liberal Democrats hybrid government has just been announced. The revised budget is still some 49 days away; however, it is clear that the tasks faced by Cameron and Clegg to restore financial order are tumultuous.
Radical fiscal and monetary policies will have to be utilised if we are to restore the government budget deficit and move forward as a prosperous nation. In particular, the retirement savings gap is huge and urgent action will need to be taken to ensure that this does not widen further. The importance of maximising retirement savings has never been so important.
One move I would be fairly confident in predicting will be our new Government imposing increases in both employee and employer national insurance contribution rates and I expect this to be phased in during the 2011-12 tax year. This will bring a more immediate focus on the planning opportunities that salary sacrifice pension arrangements may create for both employees and employers alike.
Salary sacrifice is an arrangement where employees agree with their employers to “sacrifice” part of their salary in lieu of a pension contribution. The amount sacrificed is not liable to either income or national insurance taxes as it will not be treated as income.
It is often deemed a more cost effective way of contributing to one’s pension than making regular pension contributions through net income and then reclaiming the tax relief afterwards: basic rate taxpayers will get the relief at source and higher rate taxpayers can claim another 20% through their tax return.
Indeed, salary sacrifice can be especially beneficial to the employee when the employer decides to redirect the national insurance saving (from the employer NI saved on the reduced salary payments) back into the employee’s pension plan as an additional pension contribution.
For many employers this can be a way of providing their staff with a pension contribution at no incremental cost and is often used as a means of adding to the overall staff benefit package and ensuring staff retention levels remain high.
Crunching the numbers
Having crunched the numbers for a corporate client recently, my conclusion was that basic rate taxpayers will benefit from around a 15% increase (and higher rate taxpayers a 7% increase) to pension contributions at no detriment to their take-home pay by using a salary sacrifice method of contribution compared to the more conventional means of pension funding.
In addition, this private pension funding also adds to the flexibility of a client’s overall retirement plans. The gradual increase in the State pension age for females from 60 to 65, starting this year, and the wider increase to State pension age beyond 65 will mean that people will need to consider, on an ever increasing basis, private savings to provide for earlier retirement.
It will be interesting to see David Cameron’s policies concerning this as the Conservatives have been keen advocates of raising the State retirement age sooner rather than later. One thing that is for sure is that none of us will be able to rely on the State pension payments alone to enjoy a long and comfortable retirement.
For many individuals, another attractive proposition of salary sacrifice is the ability to access private pension arrangements from age 55 and the ability to access up to 25% of these plans as a tax-free lump sum. This is not possible with State pension payments.
Another benefit of private pension savings compared to the State pension is the increased investment flexibility of these types of arrangement and the potential for higher investment growth that comes from this. By using salary sacrifice-based schemes to make National Insurance contribution savings which can then be redirected into private pension arrangements and then invested is, for many, an added element of comprehensive financial planning.
If National Insurance rates are set to rise in the 2011-12 tax year, as I predict they will be, then the importance of salary sacrifice-based pension arrangements cannot be overlooked and consideration of using them in employee benefit schemes should start now.
The arguments for salary sacrifice will become greater next year from a monetary perspective. Each tax year provides the opportunity to use the relevant pension contribution allowance (up to 100% of UK earnings or £3,600 for non earners) that can be created and this tax year is no different. Discussions with your accountant and financial adviser will be integral to make an informed judgement on this to ensure these allowances are fully maximised. The negative side to salary sacrifice arrangements is that the individual is effectively agreeing to take home a reduced salary in order to make pension contributions. This will then affect borrowing capabilities as most lenders will base their loans or mortgages on a salary multiple which will obviously be lower if one is sacrificing part of his or her salary.
It may also mean lower levels of cover under death-in-service life cover arrangements which will be based on the individual’s evidenced salary on the P60 which will not include salary sacrifice-based pension contributions. Careful consideration will need to be taken before opting into such a pension arrangement to ensure that neither of the above points is detrimental to the individual’s financial aspirations or family protection obligations.
It should, therefore, be noted that each case is unique and one should seek the advice of an independent financial adviser before committing to a salary sacrifice scheme to ensure it is suitable to a person’s requirements.
I can see the popularity of salary sacrifice-based schemes increasing in future years, especially if the rates of National Insurance contributions for employees and employers increase considerably under our new Government.
- For more information the author can be contacted at: Allchurch Bailey Wealth, Almswood House, 93 High Street, Evesham, Worcs. WR11 4DU; telephone 01386 442597, e-mail andrew.neale@ abwealth.co.uk; website www.abwealth.co.uk.
