Money: Sacrifice salary now for a big payday later

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ONE OF the changes the Chancellor made in the Budget was to hike National Insurance for employers to 12.2 per cent from 10 per cent, writes Darren Behar. The change will land most employers with a big increase in NI contributions. But pension experts advise that employees should sacrifice some salary in exchange for a larger pension contribution from their employer.

Salary sacrifice is an effective financial planning tool which can reduce an employee's income tax and employer's NI liability, and so help to avoid the massive rise in NI liabilities and benefit employees.

Salary sacrifice is a simple concept: employees elect to give up part of their salary in exchange for having the amount "sacrificed" paid into their company's pension scheme. As the sacrifice is not actually earned the employee does not pay income tax, and the employer pays no NI on the extra contribution. The technique has always been attractive but from April 1999 NI changes could make it more tempting to make these extra contributions.

An employer may also pay the NI saving into the pension in addition to the amount sacrificed. The hike to employers' NI rates will make this extra little contribution stretch even further.

Figures from financial advisers Johnstone Douglas show employees could boost their fund by 20 per cent after the rise in employer NI. For example, until April 1999 an employee who gives up pounds 10,000 a year of salary would receive an NI boost from his employer of pounds 1,000 a year. This annual sum alone would create a pension pot for a 30-year-old retiring at 65 of pounds 262,000, on top of the growth from the pounds 10,000 given up.

But the same man giving up the same amount after April 1999 would get an NI contribution of pounds 1,220 a year. This would grow to pounds 314,000 - an increase of 19.8 per cent, again on top of growth from the pounds 10,000 and any other regular contributions.

David Wright at Johnstone Douglas says: "This is a gift. It is like getting a pension boost for nothing and it is now an even bigger one, courtesy of the Government's NI reforms."

Salary sacrifice has a number of other benefits. The Inland Revenue considers the cash injection as an employer's contribution. The extra money can be used to boost the amount of tax-free cash you can take on retiring.

More obscurely, salary sacrifice can take you below the higher-rate tax band, giving a tax saving on the amount sacrificed.

Another benefit is flexibility: sacrifices do not have to be made on a regular basis. By contrast, the other form of boosting pensions - additional voluntary contributions - stands outside your main pension and must receive regular payments.

But there is no such thing as a free lunch: there are some catches to this type of financial planning. Sacrificing some of your salary leaves you with less to play with until you retire. It also reduces the amount of salary taken into account when your employer calculates the size of pension on retirement.

Similarly rebates, which the government pays if you are not in the state earnings-related pension scheme (Serps), are calculated on earnings. The rebate could be less if your earnings are reduced by salary sacrifice.

Salary sacrifice can also affect your relatives if you die before retirement, as the reduced salary will affect the death benefits paid to them. The technique can have a similar effect on redundancy payments, overtime and future pay rises.

q The 'Independent on Sunday' has produced a Guide to Direct Pensions, written by Nic Cicutti, personal finance editor of 'The Independent'. The 26-page guide, sponsored by Eagle Star, a provider of cheap pensions by phone, covers a wide range of topics linked to retirement planning. It is available by calling 0800 776666, or fill in the coupon on page 15.