A salary sacrifice pension, also known as a salary exchange scheme, is a government method-backed scheme to help employers and their workers save on tax. Here's how it works:
Agreement: An employee agrees to sacrifice a portion of their salary before it's subject to taxes (income tax and National Insurance contributions (NICs) in the UK, or income tax in Ireland). Instead of receiving this part of their salary as cash, it's redirected into their pension fund.
Tax savings: Since the sacrificed salary is not received as cash, it's not subject to taxes. This means the employee effectively pays less tax on the portion of salary they've sacrificed.
On the other hand, employers may also save on NIC/PRSI for the portion of salary sacrificed, depending on their specific circumstances.
It's important to note that salary sacrifice arrangements must be set up in compliance with the rules and regulations of Revenue, in Ireland, or HM Revenue & Customs (HMRC), in the UK. Additionally, while salary sacrifice can offer tax advantages, it reduces an employee's cash salary, which may impact other benefits tied to salary levels (such as mortgage applications or statutory payments like maternity or paternity pay). Therefore, individuals considering salary sacrifice should carefully weigh the benefits and potential drawbacks in consultation with financial advisors or HR professionals.