Can a workplace pension ease the financial impacts of the increase in National Insurance for contractors?

I’ve heard a lot of stories recently about how the IR35 changes and now the National Insurance hikes are having a huge impact on freelancers and contractors. Like IPSE research that states that on average, freelancers had experienced a 30% reduction in quarterly earnings and worryingly, a quarter (25%) had actually seen their earnings decrease by 40% or more.

And with the upcoming increase in National Insurance in April 2022, I can see workers are going to be affected again.

I’m no expert on those changes, you’ll know more than me. But I do know a lot (maybe too much) about pensions and the benefits a pension can bring to an individual in terms of tax relief. I want to try to help your freelancers and contractors today.

The two most understood methods of tax relief when it comes to pensions

A big part of understanding pensions is understanding when it is deducted from wages. There are two methods of tax relief used when deducting pension contributions – relief at source and a net pay arrangement. With these methods, the employer and employee contributions are considered two distinct elements.

The third method of tax relief which isn't so well known is salary sacrifice

There is another method in which pension contributions can be deducted from wages. This is called salary sacrifice.

What is salary sacrifice?

Salary sacrifice, also known as ‘salary exchange’, is an arrangement with you and your employees where you agree to reduce your employee’s salary by the amount they want to contribute to their pension. You will then pay this amount, plus your contribution, to their pension savings.

What are the benefits of offering salary sacrifice to contractors?

I’d summarise it into three key benefits:
1. It is a tax-efficient way for your workers to save money in their workplace pension scheme and your contractors may make savings on National Insurance contributions.
2. Your company may make National Insurance savings and, depending on how the scheme is set up, the contractor could invest all of the savings back into the pension scheme.
3. Allows you to offer an increased pension contribution to your employees, at no extra cost to you.

What are the benefits to freelancers and contractors?

The main benefit is that workers will pay less in National Insurance contributions and income tax. These savings will increase either their pension contribution or their take-home pay, depending on the basis of the scheme’s set-up. Also, as the worker's salary is reduced, there is the possibility that they may be in a favourable position when it comes to child benefits.

What difference can salary sacrifice make to a contractor's earnings?

Samantha works as a contractor with an umbrella company and earns £30,000 a year, she sacrifices 8% of her salary to her pension, which equates to £2,400 a year. Samantha’s employer sets up the salary sacrifice arrangement, where all of Samantha’s and the employer element of the National Insurance savings can be saved into her pension. In the two examples below, we compare the difference between Samantha’s salary, pension contribution and tax position before and after using salary sacrifice.

*Assumptions – tax allowance full personal UK (excl. Scotland & Wales) 2022/23– £12,570, with 20% tax rate applied. Employee National Insurance Primary threshold £9,880, with 12% NI rate applied Employer National Insurance Secondary threshold £9,100, with 15.05% NI rate applied. To find out more about how we worked this calculation out, email [email protected].

Before salary sacrifice
Salary
• Salary (Gross): £30,000
• Salary (Net take-home pay): £22,648.10

Pension contributions
• Employee contribution - 5% = £1,500
• Employer contribution - 3% = £900

Income tax paid by Samantha
• Samatha pays £3,186

National Insurance paid by
• Samantha - £2,665.90
• Employer -  £3,145.45
• Total - £5,811.35

After salary sacrifice
Salary
• Salary (Gross): £28,202.25
• Salary (Net take-home pay): £22,648.10 (no change)

Pension contributions
• Employer contribution - £2,968.31 (increase)

Income tax paid by Samantha
• Samatha pays £3,126.45 (reduced)

National Insurance paid by
• Samantha - £2,427.70 (reduced)
• Employer -  £2,874.89 (reduced)
• Total - £5302.59

Read some more working examples of what this means in terms of take-home pay and potential savings here.

Interested in setting up salary sacrifice for your workplace pension?

Contact us today to understand more information on the implementation of a salary sacrifice pension scheme. Email us today and join over 70,000 employers who are already using Smart Pension and helping hundreds of thousands of individuals save for retirement.

What you will get with Smart Pension

Give your employees access to modern features with Smart Pension:

• As members of FCSA your contractors will receive a preferential discount of 20% in admin fees and the monthly employer charge will also be waived.
• Smart Pension app
• Employees can manage pension savings anywhere, at any time with the tap of a finger. Find us on the App Store and Google Play.
• Smart Rewards
• Free, unlimited access to over 1,200 discounts at major retailers across the UK. Employees could save up to £400 a year.
• Financial wellbeing support
• It’s important to us that our members feel comfortable with their money so we provide financial education that is wider than just pensions.
And lots more…

Interested in setting up salary sacrifice for your workplace pension?
Email us today