Cash Q & A: Improving a pension arrangement where income will be small

Richard Brunton answers your financial questions

Q I haven’t worked for a number of years, as I’ve been looking after my daughters and subsequently their children to allow my daughters to continue working full-time. I have just discovered that in my last employment I contributed towards a pension scheme. The value of the funds are small and the pension company has given me an illustration showing that the income I could get from it is less than £100 a year. This is my only pension arrangement and I wondered whether there was anything I could do with it to improve what I can get?

PG, St Andrews

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A Personal pensions normally pay out a tax-free lump sum of up to 25 per cent of fund value and the rest of the fund used to provide income payments, which are taxable according to your normal income tax rates. If the pension pays out excess benefits (for example too large a lump sum) the excess is taxed at a penal rate of 55 per cent. These benefits can normally be taken from age 55, but there have been two recent changes which are relevant to you.

The first, in 2009, allows holders of personal pensions who are over the age of 60 to take the whole of the fund as a lump sum, part of which remains liable to income tax at your normal rates. This applies to holders of pension funds valued at less than £18,000.

The second change, to be introduced from 6 April, 2012, applies to very small pension funds valued at less than £2,000. As long as you are over 60, the whole of the fund can be withdrawn and three-quarters of the fund suffers a tax charge at your normal marginal rate of tax. You should ask the provider of the personal pension scheme about your options in this regard.

Q I run a small business and I’m about to take on my first employee. At interview I asked him about his benefits package with his current employer and he said that he received a 5 per cent pension contribution by way of salary sacrifice. I am happy with the level of contribution, but am uncertain about what salary sacrifice means?

SB, Edinburgh

A Salary sacrifice is where an employee formally agrees to reduce his salary and in return the employer agrees to provide an additional benefit. HM Revenue & Customs accepts properly implemented salary sacrifice arrangements as they are legally binding on the employer and employee. There are National Insurance savings arising from the implementation of the salary sacrifice and these can be used to enhance the pension contributions to be made.

For example, say your employee earned £30,000 a year and the agreement was that he would sacrifice £1,500 (5 per cent). At current national insurance rates, there would be a reduction in the employees National Insurance of £180 (12 per cent) and in employers National Insurance of £207 (13.8 per cent). Either or both parties might well agree to use part or all of their NI savings towards increasing the pension contribution, substantially increasing the employee’s pension saving by 25.8 per cent (or potentially more if the employee’s NI saving is added to the sacrificed sum) while leaving you both in the same position as if no sacrifice had been made.

A similar sacrifice arrangement could also be used for the provision of childcare vouchers. As noted above, HMRC is happy with the concept of salary sacrifice provided it is properly implemented (in particular the employee should not be able to swap backwards and forwards between the salary sacrifice agreement and the original pay package – a minimum suggested term is twelve months) and provided substantial guidance on their website at

• Richard Brunton is a tax manager within the private client & financial services department at HBJ Gateley.

If you have a question you need answered, write to Jeff Salway at The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or email: [email protected] The 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 accept no liability on the basis of this article.