My company is in the process of starting salary pension exchange.
I am 63 in December. Is it worth me joining as I have been told it could affect my state pension which I will get when I am 66. Also the works pension finishes at 65.
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Pension dilemma: Is it worth joining my firm’s salary sacrifice scheme at age 62? (Stock image)
Steve Webb replies: Growing numbers of workers are covered by an arrangement known as ‘salary exchange’ or ‘salary sacrifice’.
This relates to the way in which their works pension contributions are paid. In many cases this can be to their financial advantage, but you are wise to check for pitfalls.
To understand how salary exchange works, it is worth thinking about what normally happens when your employer pays you a wage.
National Insurance contributions are payable on your wages by both you and your employer.
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The rate for employees (provided they earn above £183 per week) is 12 per cent and for the rate for employers (provided the wage is more than £169 per week) is 13.8 per cent.
The NI rate falls to 2 per cent for higher earning employees on £962 or more a week, although the employer rate remains at 13.8 per cent,
This means that for every pound a lower or middle earner makes, more than 25p is going to the government in NI contributions.
Now consider what happens when your employer pays money directly into your pension.
You never get this money as wages so there is no employee NI contributions payable. And the employer doesn’t have to pay any employer NI contributions either.
The reason all of this matters is that when you make *employee* contributions into your pension, you do this out of wages on which both employer and employee NI contributions have already been paid.
If you could get that money into your pension without ever being paid it as a wage, you and your employer could save a lot of NI contributions, though it’s not so beneficial for higher earners.
The way that salary exchange works is that it is a deal between you and your employer. You agree to exchange (or ‘sacrifice’) part of your salary and they agree to put extra money into a pension on your behalf instead of you contributing yourself.
You save employee NICs because your salary is lower and your employer saves employer NI contributions for the same reason.
This saving can then be shared between both parties. As a result you could end up with more money going in to your pension at no extra cost.
Even though you are relatively close to retirement, there is no reason in principle why this sort of arrangement would not be attractive.
STEVE WEBB ANSWERS YOUR PENSION QUESTIONS
You would still reduce your NI contributions bill and/or get more money into your pension at no cost to yourself, though not by as much if you are a higher earner.
In the past, one reason why you might have thought twice about this arrangement would be because of potential knock-on effects on your state pension.
Prior to April 2016, part of the state pension was built up on an earnings-related basis. This meant anything which lowered your earnings would have lowered your state pension.
But since 2016 you build up state pension at a flat rate. So as long as salary exchange doesn’t take you below the floor for NI contributions (£120 per week) then you don’t need to worry about this.
There are a few other things to be aware of, but mostly relatively minor. These relate to anything where the amount you get relates to your level of pay and where you might get less if you accept reduced pay.
I’m assuming that you are in a modern ‘pot of money’ (defined contribution) pension arrangement rather than a salary-related (defined benefit) pension.
But if your company pension is salary-related you should ask if your works pension would be based on the original wage or the reduced wage level.
Similarly, before you sign up to salary exchange you should ask if any redundancy pay you might get if you were made redundant would be linked to your original salary or your reduced one?
Likewise, perhaps for your younger colleagues, they would want to check if maternity or paternity pay would be linked to the higher or lower pay figure.
Your younger colleagues should also think about whether a lower pay level might affect how much money a mortgage lender would be willing to lend them.
In most cases, however, provided that your employer is fairly sharing the benefits of salary exchange with you, then it is likely to be well worth considering, even for a couple of years.
Ask Steve Webb a pension question
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at email@example.com.
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.