TECHTALK This article originally appeared in JULY 18 edition of techtalk. Please visit www.scottishwidows.co.uk/techtalk for the latest issue. SCOTTISH INCOME TAX AND PENSION CONTRIBUTIONS What do the differences between Scottish and the rest of the UK income tax rates mean for member pension contributions and salary sacrifice? BERNADETTE LEWIS Bernadette joined the group in 2006. She has over 35 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts. From 6th April 2018, Scotland has different rates of income tax to the rest of the UK. We explain what this means for member pension contributions and salary sacrifice. IDENTIFYING SCOTTISH TAXPAYERS HMRC provides Scottish resident taxpayers with a tax code starting with an S. PERSONAL ALLOWANCE The personal allowance is 11,850 in 2018/19 for all UK taxpayers. It reduces by 1 for every 2 of adjusted net income over 100,000. So in 2018/19, the personal allowance reduces to nil once adjusted net income reaches 123,700. INCOME TAX Scottish income tax rates These rates apply to income above the available personal allowance in 2018/19 to earnings and other non-savings, non-dividend income for Scottish resident taxpayers. Starter rate: 19% 0 2,000 Basic rate: 20% 2,001 12,150 Intermediate rate: 21% 12,151 31,580 Higher rate: 41% 31,581 150,000 Top rate: 46% Over 150,000
HMRC has confirmed that Scottish taxpayers still benefit from 20% basic rate relief at source for 2018/19. Rest of UK income tax rates These rates apply to income above the available personal allowance in 2018/19 to earnings and other non-savings, non-dividend income for taxpayers resident in the rest of the UK. Basic rate: 20% 0 34,500 Higher rate: 40% 34,501 150,000 Additional rate: 45% Over 150,000 NATIONAL INSURANCE The same national insurance rates and rules apply across the UK. The following rates apply in 2018/19. Employee Earnings 8,424 to 46,350 a year 12% Earnings over 46,350 a year 2% Employer Earnings over 8,424 a year 13.8% There are no employer NICs on earnings up to 892 a week for employees aged under 21, or apprentices under age 25. The employer support allowance reduces overall employer class 1 NICs by up to 3,000 for 2018/19. Employees above state pension age and still working don t pay NICs. These factors can affect the NI savings available from salary sacrifice. Higher rate taxpayers and national insurance Outside of Scotland, 40% higher rate tax starts applying once earnings reach 46,350 for someone with the full personal allowance. This is also the point at which employee NICs reduce from 12% to 2%. However, Scottish taxpayers start paying 41% higher rate tax once earnings reach 43,430, so they effectively pay 53% tax on earnings between 43,430 and 46,350 (2018/19 rates). MEMBER PENSION CONTRIBUTIONS Group personal pensions Member contributions to group personal pensions (GPPs) are paid net of 20% basic rate tax, using the relief at source method. HMRC has confirmed that Scottish taxpayers still benefit from 20% basic rate relief at source for 2018/19. This means we have certainty that for the current tax year, Scottish non-taxpayers continue to benefit from 20% tax relief automatically on member contributions as will Scottish starter rate (19%) taxpayers. Scottish intermediate rate (21%) taxpayers will benefit from 20% tax relief automatically. If they want to take advantage of the additional 1% tax relief on pension contributions that fall into this tax band, they ll need to claim this from HMRC. They might need to complete a self-assessment tax return to do this. Scottish higher rate (41%) and top rate (46%) taxpayers will also benefit from 20% tax relief automatically. They ll need to claim the remaining tax relief they re entitled to up to 21% or 26% by completing a self-assessment tax return. This means they follow the same processes as for rest of the UK higher rate (40%) and additional rate (45%) taxpayers. Occupational pension schemes Most occupational pension schemes (OPSs) use the net pay method for tax relief on member pension contributions. Where this applies, the employer deducts gross member contributions from each member s before tax income. This means that most members automatically benefit from the correct rate of tax relief at the point their contributions are deducted from their pay. The existing disadvantage of net pay tax relief continues for some low earning OPS members, who already pay no income tax because their earnings are covered by the personal allowance. There s no mechanism for them to reclaim the tax relief on pension contributions that s available to other members. These points apply equally to Scottish and rest of the UK taxpayers.
SALARY SACRIFICE With salary sacrifice, instead of making member pension contributions, an employee agrees to a contractual reduction in their salary in exchange for receiving a higher employer contribution. They get their tax relief immediately by receiving less taxable salary, in much the same way as with net pay tax relief. The main benefit of salary sacrifice relating to pension contributions comes from the employer and employee NI savings resulting from the reduced earnings. The NI savings can be used in a variety of ways. For example, the employer can cut its costs and the employees can increase their take home pay. Or some or all of the employee and employer savings can be used to increase the value of the pension contributions. There are a few situations where the different rates of Scottish income tax create noticeably different salary sacrifice outcomes compared to the rest of the UK. We ll look at two examples, taking account of Scottish starter rate (19%) taxpayers, and those paying the effective 53% tax rate because of the national insurance trap. Salary sacrifice and starter rate tax If salary sacrifice is used with a GPP, Scottish starter rate taxpayers will benefit from 19% tax relief rather than the 20% they d receive by making a relief at source member contribution. However, this small disadvantage is offset by saving 12% NI on the sacrificed income. It s not possible to use salary sacrifice to reduce earnings to below the national living/minimum wage rates. EXAMPLE Let s compare GPP member contributions to using salary sacrifice for a lower earner in Scotland versus the rest of the UK. In this example, the 19% starter rate of tax applies to income over the personal allowance for Scottish taxpayers, and 20% basic rate tax applies in the rest of the UK. Assumptions 692.50 gross employee contribution to a GPP before salary sacrifice normal salary 13,850, post sacrifice salary 13,157.50 employer and employee both keep their NI savings. Scotland no salary sacrifice Earnings 13,850.00 Starter rate income tax 2,000 x 19% 380.00 Employee NI 13,850-8,424 x 12% 651.12 Net income 12,818.88 Member contribution 692.50 less 20% relief at source 554.00 Take home pay 12,264.88 Employer NI 13,850-8,424 x 13.8% 748.79 Scotland salary sacrifice Post sacrifice earnings 13,157.50 Starter rate income tax 1,307.50 x 19% 248.42 Employee NI 13,157.50-8,424 x 12% 568.02 Net income/take home pay 12,341.06 Employer NI 13,157.50-8,424 x 13.8% 653.22
England, Wales, Northern Ireland no salary sacrifice Earnings 13,850.00 Basic rate income tax 2,000 x 20% 400.00 Employee NI 13,850-8,424 x 12% 651.12 Net income 12,798.88 Member contribution 692.50 less 20% relief at source 554.00 Take home pay 12,244.88 Employer NI 13,850-8,424 x 13.8% 748.79 England Wales, Northern Ireland salary sacrifice Post sacrifice earnings 13,157.50 Basic rate income tax 1,307.50 x 20% 261.50 Employee NI 13,157.50-8,424 x 12% 568.02 Net income/take home pay 12,327.98 Employer NI 13,157.50-8,424 x 13.8% 653.22 Employee contribution method Tax relief NI saving Net cost GPP Scotland/rest of UK 20% n/a 554.00 Salary sacrifice Scotland 19% 12% 477.82 Salary sacrifice rest of UK 20% 12% 470.90 The slightly higher net cost of the pension contribution for a Scottish taxpayer using salary sacrifice reflects the fact that they re paying less tax on their earnings than if they were tax resident in the rest of the UK. The employer s 13.8% NI saving using salary sacrifice amounts to 95.57. Salary sacrifice and the Scottish national insurance trap It s possible for some Scottish taxpayers to save up to 53% in tax and NI by using salary sacrifice in respect of the band of earnings between 43,430 and 46,350. For example, someone who reduces their normal salary of 46,350 to 43,430 in exchange for an employer pension contribution of 2,920 would save 41% income tax plus 12% NI on the sacrificed 2,920. In practice, salary sacrifice around this band of earnings is more likely to save a Scottish taxpayer a mix of income tax at 21% and 41% and/or NI at a mix of 12% and 2%. The equivalent situation in the rest of the UK will save the taxpayer a mix of income tax at 20% and 40% and/or NI at a mix of 12% and 2%. It s possible for some Scottish taxpayers to save up to 53% in tax and NI by using salary sacrifice in respect of the band of earnings between 43,430 and 46,350.
EXAMPLE Let s demonstrate some possible tax and NI savings in this situation for both Scottish and rest of the UK taxpayers. This example considers someone who s earning enough to be paying the higher rate of tax (41% or 40%) before salary sacrifice, but falls back into the intermediate (21%) or basic (20%) rate bands with salary sacrifice. Assumptions 4,700 gross member contribution to a GPP before salary sacrifice normal salary of 47,000, post sacrifice salary 42,300 employer and employee both keep their NI savings. Scotland no salary sacrifice Earnings 47,000.00 Starter rate income tax 2,000 x 19% 380.00 Basic rate 10,150 x 20% 2,030.00 Intermediate rate 19,430 x 21% 4,080.30 Higher rate 3,570 x 41% 1,463.70 Employee NI 46,350-8,424 x 12% 4,551.12 47,000-46,350 x 2% 13.00 Net income 34,481.88 Member contribution 4,700 less 20% relief at source 3,760.00 Take home pay 30,721.88 Further tax relief available 1,130 x 1%, 3,570 x 21% 761.00 Net income after claim 31,482.88 Employer NI 47,000-8,424 x 13.8% 5,323.49 Scotland salary sacrifice Post sacrifice earnings 42,300 Starter rate income tax 2,000 x 19% 380.00 Basic rate 10,150 x 20% 2,030.00 Intermediate rate 18,300 x 21% 3,843.00 Employee NI 42,300-8,424 x 12% 4,065.12 Net income/take home pay 31,981.88 Employer NI 42,300-8,424 x 13.8% 4,674.89 England, Wales, Northern Ireland no salary sacrifice Earnings 47,000.00 Basic rate income tax 34,500 x 20% 6,900.00 Higher rate 650 x 40% 260.00 Employee NI 46,350-8,424 x 12% 4,551.12 47,000-46,350 x 2% 13.00 Net income 35,275.88 Member contribution 4,700 less 20% relief at source 3,760.00 Take home pay 31,515.88 Further tax relief available 650 x 20% 130.00 Net income after claim 31,645.88 Employer NI 47,000-8,424 x 13.8% 5,323.49
England, Wales, Northern Ireland salary sacrifice Post sacrifice earnings 42,300.00 Basic rate income tax 30,450 x 20% 6,090.00 Employee NI 42,300-8,424 x 12% 4,065.12 Net income/take home pay 32,144.88 Employer NI 42,300-8,424 x 13.8% 4,674.89 Employee contribution method Relief on payment Relief by claim NI saving Net cost GPP Scotland 20% 16.2% n/a 2,999 Salary sacrifice Scotland 36.2% n/a 10.6% 2,500 GPP rest of UK 20% 2.8% n/a 3,630 Salary sacrifice rest of UK 22.8% n/a 10.6% 3,131 The lower net cost of the pension contribution for a Scottish taxpayer reflects the fact that they re paying more tax on their earnings than if they were tax resident in the rest of the UK. The employer s 13.8% NI saving amounts to 648.60. Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given. Scottish Widows Limited. Registered in England and Wales No. 3196171. Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 181655.