Sacrifice could pay dividends
The credit crunch may have overtaken the savings gap as the major financial concern, but the latter remains a huge long-term issue.
Millions of people are not making the regular commitment to provide them with meaningful pensions once they stop full-time employment. And if the credit crunch serves to emphasise one thing only, it is that part-time jobs can dry up very quickly.
So relying on nice little supplements, which you thought would make up for the pension /savings deficit is a high-risk strategy.
So, in the midst of the current crisis, what exactly can we do when belts are being tightened everywhere just to survive?
There is one simple matter that can be attended to, that should not add to your costs and that will benefit both employee and employer at the same time.
This is ‘Salary Sacrifice’ — a misnomer as it is more beneficial than the name implies. Many big employers such as BT, LogicaCMG, Tesco and Sainsbury are making this option available to their staff and many others may follow their example.
The scheme is quite simple to operate. An employee agrees to a reduction in future pay and in return their employer will contribute to other non-cash benefits.
Typically this will be some form of pension, although some employers are using it to provide a range of benefits including childcare vouchers. The key benefit of the arrangement is that contributions are removed from the National Insurance net, cutting the tax bill for both employer and employee.
The numbers, as you will see, leaves the employee with the same take home pay.
Assume £20,000 of pre-sacrifice salary and an employee putting £1,200 a year into a pension scheme via the employer.
For salaries above £5,035 employers pay 12.8% and employees pay 11% National Insurance contributions:
For higher rate tax payers this system also means they get full income tax relief immediately, cutting out the need to include this as part of the HMRC Self Assessment.
The only concern with all of this is that the government might come to see it as a tax loophole and put a stop to it. But this has not happened yet.
So it looks like ‘win:win’ all round. The employee increases their pension funding by 31% for no cost and the employer reduces the overall employment costs to the company.
But, I have one word of caution when carrying out this sort of planning. There are potential losses, in particular the State Second Pension (S2P). There is a greater loss of benefit here for those contracting into the S2P than for those contracted out.
The other thing to check is to ensure that salary related benefits are not affected.
This said, companies can avoid this problem by introducing a notional reference salary for such purposes from which any future pay or bonus rises are calculated.
As you may have noticed, one flaw in the system is that it can only be applied to the employed and not the self-employed.
However, although it will not be possible in every case, a self-employed person could employ a spouse or partner in their business, thus reducing their income tax in that way whilst paying into a pension scheme for them as well. In which case, the calculations will need to be done together with your accountant, as the salary must be commensurate with the proposed pay.
As with all matters relating to pay and pensions, you will need to do your homework but there are some helpful booklets around to get you started.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk.