22nd June 2015
David Smith, financial planning director at Tilney Bestinvest examines the benefit of using so-called salary sacrifice to reduce student loan repayments…
With the introduction of Auto Enrolment, more and more employers are opting to use salary sacrifice as a means to reduce both their employees’ and their own costs thanks to the associated National Insurance savings.
In simple terms, salary sacrifice is an agreement between an employee and employer to reduce the level of salary of the employee in return for a regular pension contribution. As both the employee and the employer are no longer subject to National Insurance on the amount of income sacrificed, these savings can be used to either reduce the effective cost of the pension contribution or to bolster the total amount paid into the pension plan.
This is a perfectly legitimate method of pension saving. As long as the terms and conditions of employment are changed to reflect the reduction in salary, the reduction is made before the calculation of Income Tax and National Insurance, and income is not reduced to below minimum wage, then arrangement will be allowable.
Reducing student loan repayments
With clever planning, an employee can use salary sacrifice to reduce their income below certain thresholds and therefore make further savings. Take student loans for example; many students leave university with high hopes of landing a top job but can find themselves undone, with low pay and laden with debt. Repayment of student loans is 9% of income earned above £17,335 for those taking out student loans before September 2012, and £21,000 for those taking a loan out after 1 September 2012.
This can often leave many university leavers with a lot less take-home pay than they need. Taking into account Income Tax and National Insurance, a graduate will take home just 59p in the £1 for part of their income earned above the repayment thresholds. This would further reduce to 49p in the £1 for income earned above the basic rate tax threshold and a quite frightening 32p in the £1 for each pound of income earned between £50,000 and £60,000 if the graduate has two children and is in receipt of Child Benefit payments.
By using salary sacrifice, student loan repayments can be reduced. Whilst some may think this is counter-productive as it will take longer to repay the loan, in these days of austerity, there is a massive advantage for low to medium earners to have more take-home pay now, and look to repay this debt later in life when hopefully their income is greater. In the example below, an employee earning £30,000 per annum elects to use a salary sacrifice arrangement to contribute to their pension. They also have an outstanding Student Loan on an Income Contingent Basis 2
|Without Sacrifice||With Sacrifice|
|Less Personal Allowance||-£10,600||-£10,600|
|Less income tax at 20%||-£3,880||-£3,280|
|Less National Insurance||-£2,632.80||-£2,272.80|
|Less Student Loan Repayments||-£810||-£540|
|Less net pension contributions||-£2,400||£0|
|Gross Pension Contributions||£3,000||£3,000|
As you can see, the employee will receive the same gross payment into their pension in both instances, but by electing to use salary sacrifice, they have over £600 more net pay each year. What’s more, if student loans remain outstanding for certain periods, they can potentially be written off…
So why doesn’t everyone use salary sacrifice? There are potential downsides to such an arrangement. At the core of the agreement between the employee and the employer, the employee’s salary must be reduced. This could adversely affect any death-in-service benefits, which are linked to a multiple of salary, or maximum loan amounts for mortgages. Such aspects must be taken into account before the agreement is put in place.
In the end though, there are clear advantages of setting up this kind of arrangement. In addition to the above, it can help in other scenarios such as claiming Child Benefit and maintaining personal allowances. With careful financial planning, salary sacrifice can provide a benefit, even before retirement.