Earn more than you think while working less

Does this sound familiar? You’re exhausted; feeling like you’re winning neither at home nor at work. Or maybe it’s not family pressures that are impinging on you, but the desire to spend more time fulfilling your own goals or enjoying your own hobbies. But you’re fearful of the impact dropping a day’s work might have – not just on your career but also your finances.

If you’ve long considered cutting back your hours, but have feared taking the plunge, we’ll show you how, thanks to the vagaries of the tax system, you can opt for a drop in salary without suffering a similar percentage plunge in your take-home income.

And with parental leave rising to 22 weeks per child up to 12 years of age (and to 26 from September 2020), it may be the right time to avail of it.

Parental leave/reduced hours

In addition to maternity leave, which offers leave of up to about 10 months (paid and unpaid) for a new mother, and paternity leave, which grants statutory leave of two weeks a year for new fathers, Irish parents can also avail of parental leave, which is typically unpaid.

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Up until now, Irish parents could avail of 18 weeks parental leave, per child, until they turned eight. But legislation to increase unpaid parental leave from 18 weeks to 26 was introduced on September 1st. It means that parents will be entitled to an extra eight weeks of leave, with four weeks to be granted this year, and another four in 2020.

Not only that, but Government has also increased the eligible age up to the age of 12. So, for example, if you’ve already taken 18 weeks leave on a child, and they are now aged 10, you will be eligible for another eight weeks leave before they turn 12.

Many companies also provide those without children, or whose children have grown up, the option of taking a sabbatical or to work reduced hours to fulfil their own interests.

But how would it impact your pocket? Well, thanks to figures compiled by Pat Mahon, a tax partner, and Sharlene Forkan, a senior tax manager, at PwC, we can see just how it will. And remember, you can read into these figures from the other side too; if you decide to ramp up your working hours to return to a four or five day week, the benefits many not be as great as you might have envisaged.

Four-day week

For many people – parents or otherwise – the simplest option when considering working less is to lose a day’s work. Rather than work the traditional five-day week, you’ll drop back to four days.

Straight away, if approved, payroll will knock 20 per cent off your salary. So, if you’re earning €37,000, for example, this will drop back to €29,600; €48,000 will come back to 38,400; and €120,000 to €96,000 (see also table).

On a monthly basis, if you’re knocking 20 per cent off your salary, one might reasonably expect that your monthly pay check would also fall by 20 per cent. But that’s not the case.

According to Mahon, the savings are driven by how much of your income is taxed at the higher rate.

“It’s about how much of your income is currently taxed at 40 per cent and how much will be after you reduce your working week; and if it brings your income down below €35,300, you will see major benefits,” he says.

Consider someone earning €25,000. At present, they are giving up 12.6 per cent of their salary on tax, which means they get to keep 87.4 per cent a year, or €21,852. But what if they dropped back to a four-day week?

First of all, their annual salary would drop to €20,000. However, rather than lose €5,000, thanks to having to pay a lesser burden of tax, they will actually only be down by €3,228 a year, or €269 a month.

This is because their tax burden is less, at just 6.9 per cent, so they get to keep 93 per cent of their new salary. So, while their gross pay has dropped by 20 per cent, their take-home pay is only down by 15 per cent.

And the same is true as we move further up the salary scale; someone earning €60,000 a year, for example, will give up close to a third, or some 30.1 per cent, of their salary on tax. But if they drop a day’s work, and get a new salary of €48,000, their tax burden shrinks to 25.5 per cent.

In real money, this means that on a salary of €60,000, and a take-home pay over the year of €41,490, you’d expect your new take-home pay of about €33,000 by dropping to a four-day week. But thanks to the lower tax burden, it’s actually noticeably higher than this, at €35,760.

At higher salary levels, the decline in income will be more significant, given the higher level of tax paid at higher levels of salaries.

For example, on an income of €120,000, one would typically get to keep almost 60 per cent, or some €71,088, after tax. Giving up a day’s work would see salary drop by 20 per cent to €96,000 while the tax burden will mean that the decline in take-home income will be slightly less than 20 per cent, the effective tax rate will only slip from 40.8 per cent to 38 per cent, giving an annual take home pay of €59,568, a decline of 16 per cent.

Three-day week

For some people, giving up one day’s work won’t be enough; they’ll need an extra day to manage their lives. And the good news is, that while taking a 40 per cent hit to your salary will hurt, it will be cushioned by the lower tax burden you’ll face.

To illustrate, consider our worker currently on €25,000. Giving up two days means dropping back to €15,000 a year. But, once you earn less than €19,000, your tax rate plunges, so you may not actually end up losing quite as much as you might have feared.

At present, our €25,000 worker gets to keep €21,852 a year, or 87.4 per cent of their income, after tax. But dropping back to €15,000 means that they will keep 99.2 per cent, so they will come out with a take home pay of €14,880 a year – a loss of just 32 per cent on what they were netting for the full week, rather than 40 per cent.

The savings peak on a salary of €60,000, with our three-day a week worker losing just 30 per cent of their take home pay by dropping back to €36,000, compared with 40 per cent of their salary.

However, again, higher earners will not see as dramatic a relative gain, with someone dropping from €120,000 to €72,000 seeing a 32 per cent cut in their take home income. Again however, this might be better than they had feared.

Married couples can fare even better

And if you’re married, and close to the cut-off point for entering the standard/higher rates of taxation, you can fare even better by transferring the standard rate band to the higher earning spouse.

As Mahon notes, if you’re in a two-income family, and you both earn €35,300 or more, you’re getting the maximum benefit of the 20 per cent rate band. But if one goes on a four day week, then the other spouse can take the benefit of the 20 per cent band up to earnings of €44,000.

“This means that there is the potential for an extra €1,800 a year to be given to other spouse,” he says. This is because €9,000 can be transferred to the higher earning spouse, allowing them to pay tax at the standard rate on this additional income, rather than at the higher rate, as they would have done previously.

Consider a couple both earning €37,000. At the moment, their combined monthly take home pay is €5,015, or €60,180 a year. But what if one of the spouses drops back to a three-day week?

Well, their salary drops to €22,200. But this won’t have as much of a disastrous impact on the family’s finances as you might expect. This is because their effective tax rate will drop from 18.7 per cent to 15.1 per cent, which means that their new combined monthly take home pay is €4,190 – a reduction of just 16.5 per cent in take-home pay.

It’s also better than an individual’s take-home pay. Someone dropping to €22,200 could expect to give up €854 a month but if you’re married and benefit from this, you’ll lost just €825.

When we have two earners on €48,000, one spouse dropping back to a three-day week, or earnings of €28,800, also isn’t as drastic, with net income declining by just €824. This is actually €109 more than a single person would get to keep on the same salary, and shows that being married still confers benefits in the tax system.

It might also make a couple wonder whether it’s worthwhile two spouses working full time – at least financially – given the additional associated costs, such as childcare, commuting, lunches etc etc.

Summer off

The above examples are on an annualised basis and give an indication of the impact of working less. If you choose, however, to take a summer or a couple of months off, the benefits will be similar on an annual basis, but how you access them will be different.

According to Forkan, the way it should work is on a cumulative basis, which means that you get the benefit of unutilised bands during your time off, when you return to work.

So, if you’ve been off for the summer, and have just returned to work, you should see a bump in your pay cheque; if not, check with your payroll department.

Other impacts

Now it’s not just your take-home pay that will be affected by a reduction in salary. Before you make such a decision, you should also consider the impact it will have on your broader finances.

Pension contributions, for example, are typically based on a proportion of your salary. So, if your employer offers you 5 per cent of salary, and you match this, then on a salary of €60,000 some €6,000 will be going into your pension each year. But if you drop back to a four -day week your salary slides to €48,000 – which means your total annual pension contributions will be just €4,800. Over time, this can have a significant impact on the pension you hope to retire on.

Just something else to consider.