There are three types of pension schemes:
1. Basic rate tax relief at source
2. Net pay arrangement
3. Salary sacrifice.
We see via example below the best option.
Example – Luca earns a monthly salary of £2,000 and makes a contribution of say £50 via employer’s occupational pension scheme.
Three different methods of Pension tax relief
- Basic rate tax Relief at source
| Tax | Tax charged on gross salary i.e. £2,000 |
| National Insurance Contribution (NIC) Both employer and employee | NIC charged on gross salary i.e. £2,000 |
In Basic rate tax Relief at Source scheme, pension company claims 20% tax back from HMRC and in case client is a higher rate tax payer, they will need to file a tax return and claim balance relief of 20% by increasing the basic rate threshold. Please ensure not to include employer’s contribution [link]. You should get details of your own contributions from your last payslip of the tax year.
No relief for extra NIC paid.
Please note NEST (UK State-sponsored) Pension scheme used by most small employer is a Relief at Source scheme.
2. Net pay arrangement
| Tax | Tax charged on gross salary less pension deduction i.e. £2,000 – £50 = £1,950 |
| National Insurance Contribution (NIC) Both employer and employee | NIC charged on gross salary i.e. £2,000 |
Relief for tax automatic as tax charged on wages less pension contribution but no relief for extra NIC paid.
3. Salary sacrifice: as per ITEPA 2003, section 308
| Tax | Tax charged on gross salary less pension deduction i.e. £2,000 – £50 = £1,950 |
| National Insurance Contribution (NIC) Both employer and employee | NIC charged on gross salary less pension deduction i.e. £2,000 – £50 = £1,950 |
Tax relief for both tax and NIC.
Thus, we will see that salary sacrifice method is the most beneficial way of contributing to employee pensions.
Limits to pension contribution
Contributions under Point 1 and 2 above can be between
Minimum £2880 net 3600 gross
Maximum Taxable earning of the employee
Note: Even when there are not taxable earnings like in case of non-working spouse, children or grandchildren. Minimum pension contributions can be made.
Under salary sacrifice scheme – Pension contribution can be higher than taxable earnings subject to Pension Annual Allowance, only condition is that director compensation (salary + pension) should be on commercial terms.
Note of Caution
Please note, these direct employer contributions are counted towards both Annual allowance and lifetime allowances.
Roy Accountants 