Author:
Jack Munday
Chartered Financial Planner,
Saltus Asset Management Team
The power of your payslip – why understanding it can bring financial success
We have all been there – staring blankly at our payslip, crying inside at the noted tax deductions. The figure at the bottom then arrives in our bank account and we carry on with the rest of life’s challenges.
What many people may not appreciate is the sheer number of opportunities that the figures on that monthly payslip may provide you.
Sustainability in retirement starts with little ongoing tax ‘wins’ whilst you’re still working. So, let’s look into how to utilise your monthly payslip to achieve some of these small ‘wins’.
Total income and your P60
The headline figure may typically be less than you want (who wouldn’t want to earn more money right?!), but this figure can affect your planning beyond simply what you have in your pocket at the end of the month.
The level of income on your payslip could mean you’re affected by one or more of the below:
| The Annual Allowance | HMRC reduce the annual allowance (the amount you can pay into your pension each year and still benefit from tax relief) by £1 for every £2 of income above £240,000. This may seem like a lot for many, however, this also includes employer pension contributions so you can be easily caught out. |
|---|---|
| The 60% tax trap | You earned over £100,000 this tax year Congratulations…! ’now let’s take 60% tax off you.’ For every £2 you earn over £100,000, you will have your personal allowance (the starting rate of £12,570 which is tax-free) reduced by £1. If you earn £125,140, you will have no personal allowance left. The unbelievable result is that you then pay an effective 60% tax rate on this portion of income. |
| Child benefit & state pension | For those that earn over £60,000 per annum and have children running around at home, you may notice that your child benefit gets fully tapered away (even if you’re not the one in the household earning that figure!). Child benefit can be claimed by anyone who is bringing up a child, under the age of 16 (or 20 if in higher education) but is tapered away if you or your partner earn over £50,000. It’s easy to conclude you should stop claiming child benefit because what’s the point if they are getting removed right? Well, the knock-on effect here is that, if there is non-working partner, they may then lose their state pension credit for that year. Simple lesson – if one of you isn’t working, claim the benefit even if you’re not getting it (oddly enough you can elect to claim it but not get the payments). It pays off in the long run with some valuable guaranteed state pension income. |
Pension deductions on your payslip
Pensions are so much more than the annoying deductions you view them as on your payslip. Trust me, imagine if you could get up to a 72% return overnight…you can, simply by using your pension.
This is why understanding the power and structure of your employer’s pension scheme is vital. There are numerous ways that your workplace pension scheme may be established. Understanding how you can use this to your advantage, can help you mitigate those pesky tax traps and limitations listed above.
Relief at source - After tax
| Pension deduction | Payment into pension | Tax relief |
|---|---|---|
| Pension contribution taken from your earnings after income tax and National Insurance have been deducted | Pension payment is made to scheme as a personal contribution | Basic rate tax relief is claimed from HMRC (from within the pension) and credited to the plan. Higher rate taxpayers need to submit a self-assessment tax return to get any extra relief owed |
Relief at source - Before tax
| Pension deduction | Payment into pension | Tax relief |
|---|---|---|
| Pension contribution taken from your earnings after income tax but before National Insurance has been deducted | Pension payment is made to scheme as a personal contribution | Tax relief is claimed from HMRC (from within the pension) and credited to the pension plan. Higher rate taxpayers need to submit a self-assessment to get any extra relief owed |
Salary Sacrifice
| Pension deduction | Payment into pension | Tax relief |
|---|---|---|
| Pension contribution taken from your earnings before income tax and National Insurance have been deducted | Pension payment is made to scheme as an employer contribution | Payment is made gross by employer. 100% of your personal tax savings are paid into the pension as they are made at source as opposed to being claimed. |
If your pension payments are made via salary sacrifice, you may now understand why you only see an employer’s pension contribution on your payslip. This is almost always the best way to contribute to your scheme. As you can see from the above tables, this method ensures contributions are made to your scheme gross. You therefore receive the full relief as a contribution directly into your scheme. The reality of any of the other methods is that any higher or additional rate taxpayers actually have to claim the additional relief (above the basic 20%) via a self-assessment. That’s still a nice bonus on your payments. However, the reality is that you only benefit from this as a future tax reduction on your monthly income as opposed to money going directly into your pension and literally funding your retirement.
How pension contributions and your total earnings on your payslip relate to each other
Managing your pension contributions affects your ability to avoid higher earnings tax traps whilst also bringing back benefits to you. By increasing your pension payments, you could:
- Reduce your net adjusted income below £100,000 and bring back your personal allowance, avoiding that pesky 60% tax trap.
- Reduce your net adjusted earnings to below £50,000 which gives you potentially a double whammy. This will reduce your marginal rate of tax from 40% to 20% as well and bring back child tax credits for those eligible.
- Save National insurance (even more valuable now its risen to 13.25% on earnings up to £50,270, and 3.25% on anything above that).
- Reduce your student loan repayments as this is based on a percentage of your earnings.
While you’re looking into your workplace pension options, it’s worth taking five minutes to see how they are working for you. At the end of the day, what’s the point getting all of this tax relief if it’s sat in cash or in the wrong investment strategy. Default funds have their limitations so it’s worth considering if you need to make a change.
Benefits in Kind & P11D
You may be fortunate enough to see that on your payslip or P60, there are a few deductions for some wider benefits above and beyond your basic salary. This might be shown as P11D just to try and confuse you that little bit more!
You may think that it’s just a nice little bonus to get four times your salary as a ‘death-in-service’ lump sum. However, its important to ensure that whatever the pay out or structure, its working how you need it to for your planning.
There’s a few ways to help boost your planning from this and worthwhile considerations when looking into the ‘Benefits in Kind’ on your payslip:
| Benefit in Kind | Pro | Con |
|---|---|---|
| Death in service (DIS) |
|
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| Income Protection |
|
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| Critical illness |
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This is not an exhaustive list (and protection in general is an emotive subject in its own right). However, I am sure you have started to consider how these might apply to your own payslip. If not, it’s time to dig out those old HR emails and start to see what benefits you have in place and how they might affect your overall financial plan.
Drawing things together
By increasing your salary sacrifice, you can have a positive impact on your take-home pay and also start to control tax leakage in a sensible and proactive way.
This is all somewhat of a ‘whistle stop tour’ of how you can identify planning opportunities from your payslip. Rather a lot from a piece of paper you may “file” away somewhere and never look at again. The reality is that all these options feed into your overall planning and need to work for your specific goals and objectives. The key message is to not let these options pass by you. Grab them and squeeze those small efficiencies out of them for your benefit!
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All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.