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How to legally avoid the 1.25% National Insurance tax increase with this little-known tax rule

National Insurance is going up. And it’s going to affect all workers earning over £9,568 per year. But is there a way to legally avoid the 1.25% National Insurance increase?

Here, I investigate a little-known tax rule and show how it could help you keep more of your hard-earned cash.

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What’s the tax rule?

So what’s the magic secret? It’s called salary sacrifice, and it’s a legal way to reduce your National Insurance bill. It works by lowering your taxable income without reducing the amount of money in your pocket.

How does salary sacrifice work?

Salary sacrifice is all to do with payments into your company pension scheme.

It means that you agree with your employer to have a lower salary. The difference between your original salary and your lower agreed pay will go directly into your company pension scheme.

Normally, pension company payments reduce your Income Tax bill, but they will still be charged National Insurance. However, with salary sacrifice, your company pension scheme payments will not attract Income Tax or National Insurance.

Here are two examples to make it a bit clearer:

Paul earns £50,000 per year and doesn’t do salary sacrifice. He contributes 5% of his salary to his company pension scheme (£2,500 per year) through PAYE. He pays tax based on earnings of £47,500 as the pension scheme payments are tax free. But he pays National Insurance on the whole £50,000.
Geeta also earns £50,000. She agrees with her employer to do a salary sacrifice for 5% of her salary. Her taxable earnings drop to £47,500 but the company pays the £2,500 directly into her pension scheme. She saves both Income Tax and National Insurance on the pension payments.

In these examples, Geeta saves £338 (13.5% of £2,500) in National Insurance payments compared to Paul due to using salary sacrifice. She ends up with the same amount of cash each month but the extra £338 is paid into her pension scheme per year. She is able to contribute an extra £3,380 to her pension pot over a 10-year period.

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How how much National Insurance could you save?

By using salary sacrifice, you could save a significant amount of National Insurance. The amount you save depends on your earnings and how you pay into your pension scheme. If you earn £50,000 and contribute 5% to your company pension scheme, then salary sacrifice would save you £338 per year in National Insurance contributions. 

If you earn £25,000 and contribute 5% to your pension scheme through salary sacrifice, then you will save £169 per year in National Insurance contributions.

What do you need to do to save National Insurance?

If you want to do salary sacrifice, then ask your employer’s HR department if it is available at your company. Not all businesses offer it as an option. You will usually receive a form to complete to confirm that you wish to do salary sacrifice.

Is there anything else to consider?

There are a few other things to think about when you are considering doing salary sacrifice:

It may affect a loan or mortgage application. Your total gross salary will be lower with salary sacrifice, so this is something to consider if you are moving or re-mortgaging soon.
If you are a low earner, then reducing your National Insurance contributions may affect your entitlement to a basic or full state pension when you retire. Check the government website for more information on State Pension eligibility.
Salary sacrifice may also affect the level of other benefits like maternity pay or your level of life cover. Consult your union or Citizens Advice for more information.

The post How to legally avoid the 1.25% National Insurance tax increase with this little-known tax rule appeared first on The Motley Fool UK.

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