Super-charged salary sacrifice

The recent announcements on the new Health and Social Care Levy and corresponding rise in tax on dividend income will boost the attractiveness of salary sacrifice in the years ahead.

As most readers will know, the biggest draw of salary sacrifice is the National Insurance (NI) savings that can be made, both by the employer and employee. Under current rules, employers can save 13.8% on all contributions where salary is above £737 per month. Some, or all, of this saving can be passed on to the employee in the form of higher pension contributions. On top of this, the employee themselves will save 12% on earnings between the primary threshold and upper earnings limits, and 2% on earnings above this.

For 2022/23, only NI is going up by an extra 1.25% points. So the main rate for employees becomes 13.25% – not a 1.25% increase in the rate paid as it has been marketed, but actually an increase of more than 10%. The 2% higher rate changing to 3.25% is a 62.5% hike, with the employer rate moving from 13.8% to 15.05% being a 9% increase.

The self-employed (class 4) contributions main rate will also rise from 9% to 10.25% and the higher rate from 2% to 3.25% – so they too will have an increased incentive to reduce profits by saving in pensions. There are no increases for class 2 or 3 contributions.

From April 2023, NI rates are planned to revert to this year’s rates – but we will then have the new Health and Social Care Levy instead. This will be payable by employers, employees and the self-employed at 1.25% on all earnings above the National Insurance thresholds. The crucial difference here, though, is that it will be payable by workers over state pension age, and their employers.

For older workers who don’t currently pay NI, there is no tax advantage to salary sacrifice over making personal pension contributions, albeit there may be administration benefits. From April 2023, salary sacrifice will look like the more attractive option for this cohort too; with both the employee and employer subject to the levy, total savings will be 2.5% on earnings above the threshold.

On top of this, we have the increase to the Dividend Tax rates – from 7.5%/32.5%/38.1% to 8.75%/33.75%/39.35% – a rise of over 16% on the basic rate. This is another boost to the salary sacrifice argument – put your money into your pension to avoid the Dividend Tax hike. This increase is also an incentive to make the most of all ISA and pension allowances available.

Of course the inevitable Budget rumour mill has started on whether we will see cuts to the annual allowance announced on 27 October. I have no real idea how likely this is – but in any event, it is worth remembering that the annual allowance charge works by charging Income Tax on the excess contribution. It doesn’t charge NI and there’s nothing to suggest the levy would apply (unless any anti-avoidance measures are announced later), so savings could still be made where salary sacrifice is used.

This article was previously published by Sipps Professional