Why a pension may be better than a pay rise
A pay rise is always welcome news, but there’s an alternative that could leave you even better off, particularly as you get closer to the age when you can take money from your pension.
How much of your pay rise will you see?
This depends on your total income. If your earnings including the pay rise are above £50,270, you’ll need to pay at least 40% Income Tax and 2% in National Insurance Contributions (NICs). That means that a £1,000 pay rise ends up as £580 in your bank account.
If your total earnings are between £12,570 and £50,270, you’ll pay 20% Income Tax and 8% NICs meaning a £1,000 pay rise translates into a slightly healthier £720.
What about your employer?
To give you a £1,000 pay rise, your employer will need to pay employer’s NICs. In most cases this is charged at 13.8%, meaning a total cost to them of £1,138.
What’s the alternative?
You and your employer could agree, that instead of giving you a pay rise, your employer will pay an equivalent amount into your pension, known as ‘Salary sacrifice’. The big advantage for your employer is that they would not need to pay NICs on the money they pay into your pension. On a £1,000 pension contribution they would save £138.
You would also escape NICs and Income Tax on the amount your employer pays into your pension.
Do I pay tax when I take the money out of my pension?
When you reach 55 (or 57 from 2028) you can take money from your pension. In most cases you can take 25% of the pot as a tax-free lump sum, with the remainder subject to Income Tax when you take it out.
Let’s take an example of £1,000 invested in a pension that doesn’t grow and isn’t subject to any charges to show the difference swapping a pay rise for an employer’s pension payment can make:
| 20% Income taxpayer | 40% Income taxpayer | |
| Fund value | £1,000 | £1,000 |
| 25% tax free | £250 | £250 |
| Income Tax | (£150) | (£300) |
| Amount in bank account | £850 | £700 |
| If taken as a pay rise | £720 | £580 |
If you’re currently paying 40% Income Tax and are likely to be a 20% taxpayer when you take the money out, an employer pension contribution will be much more tax efficient than a pay rise. A £1,000 pay rise now would give you £580 whereas a Pension could leave you with £850, assuming no growth/loss on your fund and no charges.
Getting a boost from your employer
Your employer will benefit financially by paying money into your pension rather than giving you a pay rise, because they don’t need to pay employer’s NIC. On a £1,000 payment into your pension, they save £138.
Many employers use some or all this saving to boost the amount they pay into their employees' pension.
What next?
You can give us a call on:
0800 622 323
You can find out more about our pensions or open a new pension online:
The value of investments and any income from them can rise or fall and you may get back less than invested.
The tax treatment of pensions depends on individual circumstances and may change in the future.
NFU Mutual Financial Advisers advise on NFU Mutual products and selected products from other providers. When you contact us, we'll explain the advice services we offer and the charges.
Financial advice is provided by NFU Mutual Select Investments Limited.
Looking for financial advice?
If you’re not sure how to put your financial plan in place, one of our NFU Mutual Financial Advisers can help. They'll be able to recommend products that are right for you based upon your personal circumstances. You can book an appointment with an NFU Mutual Financial Adviser by either calling: 0800 622 323 or requesting a call back.