Salary exchange is a great way for both you and your employees to reduce your National Insurance Contribution burdens. Here is what you should know about introducing a salary exchange scheme into your organisation.
Introduction
Salary exchange (also known as salary sacrifice) is a workplace arrangement where an employee agrees to give up a proportion of their salary in exchange for a non-cash benefit. Examples of such arrangements include pension contributions, cycle to work schemes, and workplace nurseries.
This article will focus on the benefits of using salary exchange for payments into pension schemes using the Smart Pension Scheme approach. This operates in the following way:
- the employee gives up an amount of cash salary equivalent to the contributions they are making to your approved pension scheme;
- you agree to increase employer contributions to the pension scheme by an equivalent amount;
- employees are notified in advance that the new arrangements will automatically apply from a particular date in the future;
- participation in the scheme brings about a change to the terms and conditions of employment of the participants.
Where employees use salary exchange for pensions, their taxable pay reduces. Consequently, National Insurance Contributions (NIC) are reduced for both the employee and you, the employer.
To avoid disadvantaging employees, their base salary (actual salary before exchanged pension contribution) can still be used for the purpose of calculating any salary increase as the result of a pay review. This also applies to holiday pay; the employer’s pension contributions; sick pay and life insurance; redundancy payment; and, where applicable, occupational maternity/paternity/adoption pay.
Once implemented, the reduced NIC’s resulting from lower taxable pay will save your organisation money in the long term. With the current cost of doing business crisis, it is essential to utilise all means available to streamline your overheads.
How salary exchange works
This complex topic is best explained with examples that illustrate how you and your employees may save on NIC with salary exchange (with updated rates from September 2023).
For a single employee, who contributes £100 per month into their pension fund, the savings would look similar to this:
Employer NIC savings:
Employee NIC savings:
For example, an employer with 30 staff members, with an average salary of £28,000 per annum, could save over £5,800 per year in lower NIC contributions, assuming a contribution basis of 5% match of gross basic pay.
The Smart Pension Scheme
At Lucas Fettes Financial Planning, we operate with the Smart Pension Scheme. When it comes to the Smart Pension Scheme, there are several steps you must take to ensure that variation of terms and conditions are effective and compliant with HMRC regulations.
The first step is to agree a ruleset for the scheme and communicate this to your employees. It is important to note that salary exchange is not a pension arrangement, but rather a tax relief system within the payroll environment. It achieves NIC savings by deducting the exchange value prior to the PAYE tax calculation. These are the documents that must be communicated:
- for existing pension members, you must give advance notification that they will move onto a salary exchange basis on a future date with the option for employees to reject the change;
- newly hired employees should be notified when they commence employment that they will be automatically enrolled on a salary exchange basis, and again, have the option to reject this;
- the rules of the salary exchange should be drawn up and made available to all employees. Within these rules, you must set out the exchange terms such as:
- start date;
- maximum allowable exchange contributions;
- any NIC savings rebate being added to the employee’s pension fund;
- and the conditions of the employee being able to change the exchanged amount.
- example payslips showing the before and after exchange salaries. This should be trial run before the exchange goes live and audited to confirm the exchange has been calculated properly;
- pension scheme documentation should include details of the exchange arrangement;
- and the monthly pension schedules should be checked to confirm that the contributions of employees enrolled in the exchange have been amended to employer only.
Factors you should consider before implementing salary exchange contracts
As mentioned before, the main advantage of salary exchange is the reduced NIC for both the employee and the employer. You can reinvest any NIC savings back into your organisation or into your employees’ pension. Moreover, they receive higher take-home pay through paying less NIC. Also, high earners get their income tax relief immediately instead of having to claim it through their tax return.
If an employee opts out of a salary exchange agreement, you will need to revert to the former tax relief system and adjust their refund to pay back the NIC because the savings only apply if their money remains inside a pension fund.
How to decide if salary exchange is the right choice for your organisation
With a significant number of tax advantages, you may be wondering why all employers do not set up a salary exchange pension scheme. The main perceived problem is the complexity of implementing such an arrangement. It requires the involvement of your Finance, HR and payroll functions and a change to your employee documentation, pension submissions and monthly administration to ensure it is working as intended. For smaller organisations, this may not be viable, but for medium-sized and larger organisations, it could free up money to be re-invested into your staff.
As this is a complex choice with many factors to consider and calculate, engaging with a specialist financial adviser would be the best approach to help you decide whether salary exchange will benefit you or your employees.
How can we help you?
Could Salary exchange be a viable option for your organisation? Our expert team can help you make this decision.
If you would like to discuss the salary exchange options that are available, or if you wish to arrange an initial consultation, then please fill out the contact form below. Alternatively, you can call 01603 706 820 or email info@lffp.co.uk.
Important information
The contents of this article are solely for informational purposes and nothing in it is intended to constitute advice or a recommendation. You should not make any investment decisions based on its content. The impact of taxation (and any tax relief) depends on individual circumstances. This has been prepared based on our current understanding of UK Law, Taxation and HMRC practice, all of which could be subject to change in future.
The value of investments can fall as well as rise and it may not always be possible to receive back the sum initially invested. Past performance is not necessarily a guide to future investment returns.
