Tax-free Personal Allowance increased by £700 with ‘free money’ pension loophole

Workers who put more money into their company can increase their annual salary and retire a year earlier, according to one expert. Many companies offer a benefit called salary transfer, which allows employees to swap some of their salary for a benefit, such as childcare, health insurance, or a pension. Scottish Widows found that workers on an average salary of £34,963 a year could retire a year earlier by opting for the pension version of salary exchange.

Scottish Widows calculated that average salary workers – who take home £27,294 annually after tax – could increase their take-home pay by £140 a year because paying money into a personal pension increases their tax-free allowance by at least £700 on top of the £12,570 personal tax allowance.

By contributing more to their pensions, workers pay less for National Insurance, and their employers also save on employer National Insurance, which is due to increase this year.

Salary transfer, which was known as salary sacrifice, means both employers and employees pay less tax and .

Experts have argued that the announced in last year’s budget by Chancellor Rachel Reeves could push more employers into offering salary sacrifice.

Gary Smith, partner in financial planning at Evelyn Partners, thinks more businesses will offer salary sacrifice “could look towards these schemes to reduce costs”.

He said some employers may even pass their savings on NI to their employers via their pension.

Pension contributions are made net after both income tax and NI have been deducted. You do not get the NI back. As for income tax, your pension scheme automatically adds the basic rate of 20% tax relief to your pension, which increases your tax-free allowance.

If you are a higher- or additional-rate taxpayer, you can claim back the rest of the income tax in your self-assessment tax return. For example, if you pay the higher rate and make a net pension contribution of £80, an extra £20 is added to the scheme (for a total £100 contribution), and another £20 can be claimed back.

Smith said pension contributions can help people reduce their ‘adjusted net income’, which is calculated excluding pension contributions.

Smith said: “Similarly, once your adjusted net income is above £60,000, you start paying the high-income child benefit charge, which reduces your entitlement. Pension contributions can also save you from paying 45% tax on any portion of your income if this is above the £125,140 additional rate threshold. Making pension contributions through salary sacrifice streamlines all these advantages.”

If they let their employer top up their pension, employers have to offer a minimum of 3%.

Employers can offer salary sacrifice to all employees, as long it doesn’t reduce their salary to below minimum wage.

Salary transfer, or salary sacrifice explained

1. Employers should get in contact with their payroll to see if they offer salary transfer for the employer’s pension scheme.
2. Employees will need to agree to the change in their contract or through an agreement letter. Employers will need employees’ permission before entering them into a salary sacrifice scheme. If they don’t agree to salary sacrifice, employers will need to take their employees’ pension contributions in the usual way.
3. Employers will need to create a salary sacrifice worker group in their Online Services account. Make sure this is set up so that all contributions are paid by the employer and that the worker group is labelled accordingly eg ‘Salary sacrifice’. Please note, you’ll still need a standard worker group for those employees that don’t agree to pay in their pension contributions using salary sacrifice.
4. Once the employer has received their employee’s permission and has their new worker group in place, they can set up the salary sacrifice scheme through their payroll. Before sending us any pension data over to us, make sure your worker groups match your payroll and, if submitting a data file, your worker IDs have been updated on the file.