Cash clinic: £1,000 pay might be worth sacrificing for a better pension

I earn 25,000 a year and I'm already paying 3 per cent into the scheme, as is my employer. I am considering salary sacrifice, where 1,000 of my pay a year is diverted into the company pension scheme. Is this a good idea? What are the pros and cons?

SM, Inverness

A In the current economic climate, everyone is seeking to squeeze the last drop of value out of every pound they earn, so the idea of sacrificing part of your salary may seem an alien concept.

But it's a good way of boosting your pension savings and reducing your tax bill. Pension contributions already attract tax relief, but you can make further savings on your contributions by opting to sacrifice part of your salary and have this diverted instead into your company pension scheme.

Before salary sacrifice the contribution by yourself and your employer to the pension pot amounts to 1,650. This comprises your contribution of 3 per cent of 25,000, amounting to 900 (750 plus tax relief), and the employer contribution of 750.

After the 1,000 salary sacrifice we have your contribution as 3 per cent of 24,000, amounting to 864 (720 plus tax relief), and an employer contribution of 3 per cent of 24,000 - plus 1,000 from salary sacrifice - making a total of 1,720. This gives a total contribution of 2,584.

The increase to the pension contribution resulting from salary sacrifice amounts to 934, and taking away the 696 (1,000 less tax and employee's national insurance), makes a net boost to your pension pot of 238.

In your case, not only would your own pension pot receive a boost, but your employer has also saved 128 in national insurance contributions, and may agree to add this saving to the pension pot as well, giving a total boost of an additional 366 into the pension for every 1,000 sacrificed.

There are some disadvantages to salary sacrifice to consider, however. The salary sacrifice obviously does result in a lower annual pay rate which may then affect other salary based benefits, such as future wage increases, overtime payments, shift payments and bonuses.

If you are still fortunate enough to be in a final salary pension scheme, a lower salary would impact on you negatively. This can be avoided by the employer introducing a "notional" or "reference" salary (the amount before the sacrifice) from which these benefits are calculated.If you are anticipating maternity leave, any salary sacrifice would need to be considered carefully, as statutory maternity pay will always be based on the official lower salary rather than the higher "notional" salary.

Salary sacrifice can be used for other employee benefits as well, for example child care vouchers, mobile phones and bus passes.

This is definitely something worth considering, but you would have to take a long hard look at your personal circumstances and the impact this drop in salary could have.

• Marion Bagley is a tax manager at HBJ Gateley Wareing. If you have a question you need answered, write to Jeff Salway, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or e-mail: [email protected].

This above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given. The Scotsman Publications Ltd and HBJ Gateley Wareing accept no liability on the basis of this article.