How to boost your pension with NIC savings
Money Wise spring 2007
There is a legal and relatively simple way for employees to save national insurance contributions (NICs) and boost contributions to their pension arrangements. Instead of making personal contributions to your pension, ask your employer to make the contributions instead.
If you are an employee under state pension age who is not a member of a contracted out occupational pension scheme, in the coming tax year (2007/08) you will pay NICs:
- At 11% on your earnings between £100 a week and £670 a week; and
- 1% on all your earnings above £670 a week.
So, for example, on earnings of £50,000 a year, your 2007/08 NICs bill would be £3,412.
In addition your employer has to pay 12.8% NICs on all of your earnings over £100 a week. On earnings of £50,000 a year, your employer would have a NICs bill of £5,734, bringing the combined total to over £9,000.
The high level of NICs can be turned to your benefit by using salary sacrifice to fund pension contributions. This involves agreeing to a lower salary in exchange for pension contributions made by your employer. The technique can increase a pension contribution by nearly 15% if you are a higher rate taxpayer and all your and your employer’s NIC savings are directed to the pension arrangement.
For example, you would like to contribute about £5,000 of your salary to a pension arrangement. By taking the salary sacrifice route, the amount invested in your pension would be £723 more than if you made a pension contribution personally, but the cost to you and your employer would be exactly the same.
If you are interested in the arithmetic, you will find the details below. The mechanism works equally well with bonuses or future salary increases.
However, there are downsides that we can explain to you before you discuss the possibility with your employer. For example, you are reducing your salary, which could affect your entitlement to employee benefits, such as life and health cover, depending on your employer’s rules. You may also limit how much you can borrow under a mortgage. We can also help with setting up the documentation, which is the key to gaining acceptance by HMRC.
How it works
The difference is essentially caused by the extra NICs. Assume that you are a higher rate taxpayer and earn well over the NIC upper earnings limit. If you make a personal contribution, you will make it from salary on which your employer has paid NICs of 12.8% (£640 on the £5,000) and you will have paid 1% NIC of £50. The employer has also deducted income tax of £2,000 at 40%.
At a net cost of £2,950, you can make a pension contribution and get tax relief at 40% of the gross of £1,967. So the amount invested is £4,917. The simple alternative is that your employer makes the pension contribution direct, consisting of the £5,000 salary sacrifice plus the £640 employer’s NIC that has been saved.
If you earn less than £34,840 in 2007/08, the benefit is greater because the salary you sacrifice will be in the 11% NIC band. The actual uplift in contributions is over 31%.