Increase Take Home Pay | Salary Sacrifice Explained (Scotland)
We are going to be looking at Salary Sacrifice in Scotland and how it can be used to increase your take-home pay while still keeping your Pension Contributions stable!
Now I have done a video on Salary Sacrifice before (link below). Still, I did mention because Scotland has slightly different tax rules, the examples I provided in that video wouldn't be applicable. So that's what we will be doing in today's video!
Salary Sacrifice or Salary Exchange means you give up a proportion of your Salary, not because you want to earn less money, but you do it as part of an agreement with your employer in exchange for a non-cash benefit. These benefits will vary from employer to employer from company cars, and life insurance cover, however, the most common one, and the one we will be focusing on in this video will be Pension Contributions.
As the name suggests you do need to earn a Salary to take part in Salary Sacrifice so this will only be applicable if you are employed and not if you are self-employed.
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0:00
Hey everyone, welcome back to my video
0:02
In today's video, we're going to be looking at salary sacrifice in Scotland
0:06
and how it can be used to increase your take-home pay. Now, I have done a video on salary sacrifice before
0:12
which I'll link now, but I did mention in that video that because Scotland has slightly different tax rules
0:17
the examples I provided in that video wouldn't be applicable. So that's what we'll be doing in today's video
0:22
I'm Kozun from Financial Madness, helping you be better with your money
0:26
So let's start with the basics and understand what salary sacrifice
0:36
or what is sometimes called as salary exchange, means. Well, as the name suggests
0:40
you basically give up a proportion of your salary, not because you want to earn less money
0:45
but you do it as part of an agreement with your employer in exchange for a non-cash benefit
0:50
Now, these benefits do vary from employer to employer, from company cars, life insurance cover
0:56
However, the most common one, and the one that we'll be focusing on today's video
1:00
will be pension contributions. Also, as the name suggests, you do need to earn a salary to take part
1:05
in salary sacrifice. So this will only be implicable if you are employed
1:09
and not if you are self-employed. The way that salary sacrifice works
1:13
is that you make an agreement with your employer to give up some of your salary
1:17
and they, in return, will give you a non-cash benefit. Now, the amount you can sacrifice
1:22
will depend from employer to employer. However, usually when we are talking about pension benefits
1:27
it's usually you as the employee who can define how much of your salary
1:31
you would like to give up or sacrifice. But obviously, like with all financial decisions
1:35
it's always best to speak with your provider before settling on a decision, as it's not impossible for employers
1:40
to have their own predefined rules when it comes to salary sacrifice
1:44
which may limit how much you can sacrifice and how you can use it. So always check with them before going any further
1:50
In addition, in most cases, once you have enrolled in salary sacrifice
1:54
you can normally opt out or change the sacrificed amount at any given time
1:58
But again, just double-check with your employer. You may also want to check if you've subscribed
2:04
So why should we even consider the option to salary sacrifice? So there are two key benefits to you as an employee
2:11
Number one is that you pay less tax when you salary sacrifice, and that is because the proportion that you do sacrifice
2:17
is no longer subject to any tax whatsoever. So in a normal scenario
2:21
your salary is usually subject to both income and national insurance tax when you get paid
2:25
However, these taxes won't be applied on the proportion you salary sacrifice
2:29
Therefore, you pay less tax. And number two, if you are already enrolled
2:33
through a workplace pension through the default auto-enrollment route, actually changing your pension contributions
2:39
from auto-enrollment to salary sacrifice can see an uplift in your take-home pay
2:44
And in addition to this, you may not even know this, but employers also have to pay national insurance tax
2:49
when they employ you. And the amount they have to pay is of course based on your salary
2:54
So when you reduce your salary through salary sacrifice, your employer also pays less national insurance tax
3:00
And in some circumstances, the saving the employer gets when you do this
3:04
can be passed on to you as a benefit. Check with your employer if this is the case
3:09
Now, in case that was all confusing, don't worry, I will explain this better with an actual example
3:14
Now, before we move on to the example, just a quick note on how salary sacrifice works
3:18
with defined benefit pensions. Now, the answer to this, unfortunately, is unclear
3:24
Salary sacrificing through defined benefits will ultimately reduce your benefits from the scheme
3:29
However, how they use the money when you do sacrifice is up for question
3:33
I would encourage you to speak with your employer to find out more. I'm happy for you to reach out to me
3:38
to discuss it if you want to, but honestly, I've looked so much on the internet and I can't find a good, clear example
3:44
of what happens to defined benefit schemes. So do let me know in the comment section down below
3:48
Now, moving on to the demo, but I just want to reiterate that this is only going to be applicable
3:52
for those that are employed in Scotland. If you are anywhere else in the UK
3:56
you can check out my earlier video on salary sacrifice and go to this timestamp here
4:00
where you can jump straight into the demo. All right, let's continue
4:04
Cool, so here is the salary sacrifice calculator. I'll put a link in the description box down below
4:08
if you want to use this yourself. But essentially, what I will be doing here
4:12
is going through a typical scenario when you contribute through your pension
4:15
via auto-enrollment versus how it works when you salary sacrifice instead. And you can see the difference
4:21
between your take-home pay and your pension pot. Cool, so this is the scenario that we'll be looking at
4:26
We'll be looking at an individual who earns £26,000 per year. I've broken down the numbers in annual and monthly basis
4:34
Now, all you have to do is just enter the gross salary in your example if you want to have a look
4:39
because everything is automated. So depending on how much you put in, the tax rules will apply accordingly
4:45
So in this example, we have an individual who is earning £26,000 per year
4:50
They are already contributing 5% of their pensions through the normal auto-enrollment route
4:55
This works out to be £1,040 per year. Their taxable income, so this is how much
5:00
of their gross salary is actually subject to tax, is £13,430. And from this, £2,667 will be taxed on income
5:10
and National Insurance Tax will take out £1,779 for that year, making their take-home pay
5:17
for that year £20,513. Now, if we move over at their pension pot
5:23
we can see that they've added £1,040, which is the same as their 5% contributions
5:29
They also get tax relief from the government, which works out to be £260
5:33
And the employer also contributes to the scheme at 3%, which is, again, the minimum that they have to do
5:39
So this works out to be £780. So at the end of the year, their pension pot has grown by £2,080
5:46
So moving on to example two, where we have the exact same scenario, but instead of doing 5
5:52
through auto-enrollment pension deductions, they've decided to salary sacrifice 5% of their gross salary
5:58
So as you can see here at the top, 5% of 26,000 is £1,300
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making their gross salary £24,700. And I've just added the salary sacrifice number here
6:10
That means their taxable income is at £12,130, which is significantly less than the example previous
6:17
Their income tax will be £2,404 and National Insurance, £1,607, making their take-home pay £20,688
6:27
Now, if we look at the take-home pay, we can see that their take-home pay has increased by £175
6:33
by going through the salary sacrifice method. And that is because less of their gross salary
6:38
is subject to income tax and National Insurance tax. But let's look at their pension pot as well
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because this is obviously still important. Their sacrifice amount goes straight into the pension pot
6:48
so that's £1,300. The employer still contributes 3%. This is still £780
6:54
Now, I have put employer NI savings here, and I have kept it at zero because it will depend on employer to employer
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But remember, this is the savings that they get from you salary sacrificing, because they too obviously have to pay
7:04
less National Insurance tax. And sometimes the employers will transfer all or some, or maybe in certain cases
7:10
none of the benefits to your pension pot as well. So I have kept at zero
7:14
but obviously we can increase this number. But even if we do keep this number at zero
7:17
you can see the grand total is the same as the previous example
7:21
which stands at £2,080. So to sum up, the take-home pay difference
7:26
we saw an increase of £175.39 through salary sacrifice. And the pension at the minimum is the same
7:35
It can increase if the employer does provide extra benefits through the NI savings route
7:40
Cool, so hopefully that has made things clear. Pause the video now if you want to see another example
7:43
of someone on a higher income salary. So let's go through the pros and cons
7:48
starting with the obvious benefit. And that is, because you are reducing your gross salary
7:53
this means you and your employer pay less tax, which means if you were previously paying
7:58
into a pension via the regular auto-enrolment route, and you switch to salary sacrifice
8:03
this is likely going to result in an increase in your take-home pay, while still keeping at least the same pension contributions
8:10
And that moves on to my next benefit, and that is some employers actually redirect
8:14
their tax savings when you do salary sacrifice towards your pension pot as well
8:19
So that means not only is your take-home pay increasing, but your pension contributions as well
8:23
And obviously, the more money you do put in your pension means it's more likely to compound even faster
8:28
and more likely to generate even higher returns. And lastly, there is no penalty
8:33
if you do decide to change your mind about salary sacrifice. So if you have joined the scheme
8:38
and a few months later you would like to stop, most employers will let you
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It is worth noting, however, in most cases, when money is salary sacrificed
8:46
this money cannot be returned to you. So be sure to check with your employer
8:49
for all the fine details. Now, moving on to the cons, one drawback of salary sacrifice
8:55
is that it may negatively affect your other workplace benefits. For example, if your employer does provide you
9:01
with life cover or life insurance, then the benefit you would be entitled to
9:06
is normally associated to your gross salary. So reducing your salary through salary sacrifice
9:11
would reduce these benefits. Again, be sure to check with your employer on all the implications associated with salary sacrificing
9:18
as this can differ between employers. Another drawback is that it can affect
9:22
how much you can borrow, particularly if we want to focus on mortgages
9:27
One of the factors that does determine how much you can borrow from the lender is your household income
9:32
So reducing this through salary sacrifice may affect how much you can borrow from lenders
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So if you are looking to get a property and you're on the bubble on how much you need to borrow
9:41
versus how much you can, it's probably worth delaying salary sacrificing once you get the keys
9:47
And number three, your entitlement to state benefits can also be affected
9:50
such as statutory sick pay and maternity leave, as these are usually linked towards your gross salary
9:55
And lastly, as I've demoed in my example, there is more benefits to salary sacrificing
9:59
if you are on a higher income threshold, as the tax rates on these bands are significantly higher
10:04
than the ones on lower bands. So if you are on a low income salary
10:08
then salary sacrifice won't be as advantageous. Cool, so that is it for this week's episode
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Let me know in the comment section down below if you do have any questions
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Also, be sure to like and subscribe for my future content. See you later, bye
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