As the salary is being ‘exchanged’ rather than paid, both you and your employees do not pay National Insurance Contributions (NIC) on the exchanged amount. The exchanged amount can then be paid into the employee’s pension plan as an employer contribution. The same pension contribution is received, but both you and the employee are better off due to the NI saving.
In recent years Her Majesty’s Revenue and Customs (HMRC) has reviewed its practices to simplify them, and to allow the operation of salary exchange schemes to work alongside auto-enrolment. This means that employers can now effectively establish a salary exchange scheme and benefit from the advantages.
What are the benefits of salary exchange for employers?
With employee pension contributions due to increase to 5% over the next few years under automatic enrolment the savings for your business could be significant. Whilst many employers have set up their qualifying workplace pensions on auto-enrolment minimums the phasing of contributions is due to commence from April 2018 so both employer and employee savings will grow steadily over the next few years.
* Employer savings based on employee paying contributions on the 2018/19 minimum 3% contribution levels for qualifying earnings. Where employees pay higher contribution levels or contributions are based upon an alternative set basis savings may vary.
** Employee savings based up member paying 2018/19 minimum contributions on qualifying earnings with total earnings not exceeding £44,980. For an individual with earning greater than this amount the employee NI saving will be reduced. Johnson Fleming Limited is authorised and regulated by the Financial Conduct Authority.
Salary Exchange, also known as Smart Pay, Salary Sacrifice, and Salary Conversion, is the term that HM Revenue & Customs (HMRC) describes as a contractual arrangement whereby an employee gives up the right to receive part of their cash remuneration, usually in return for their employer’s agreement to provide some form of non-cash benefit. If employees have previously reclaimed higher or additional rate tax relief, they will need to notify their local tax office of this change if they pay contributions via the Salary Exchange method as a member of their current pension plan. Johnson Fleming Services Limited provides support to many leading UK employers regarding the Auto-enrolment of employees into Workplace Pension Schemes which is not regulated by the Financial Conduct Authority. Johnson Fleming Services Limited is therefore not regulated to provide financial advice or authorised as tax advisers or employment law specialists. Johnson Fleming Services Limited is registered in England and Wales, registration number 08373606. Registered office: Fleming House, Bromsgrove Enterprise Park, Bromsgrove B60 3AL.
Statutory auto-enrolment contributions
Minimum employer contribution
Total minimum contribution
Figures assume you will receive NIC savings on all of the ‘exchanged' employee contributions at 13.8%.
What are the benefits of salary exchange for employees?
The benefit received as a result of the exchanged salary and the reduction in salary should cancel each other out. The advantage beyond that is that the employees should also pay less in National Insurance Contributions. Like the employer, the employees pay National Insurance Contributions on salary, so the lower their salaries the lower their National Insurance Contributions will be. This should produce an overall saving for employees.
National Insurance saving Your employees will receive a National Insurance Contribution saving on exchanged contributions of between 2% and 12% (dependent on their earnings).
Tax relief Employees who are higher or additional rate tax payers will receive their higher rate tax relief at source, rather than having to reclaim it through annual assessment.
Childcare and student loans Reducing salary can also help employees to postpone repaying student loans. It can also enable those earning just over £50,000 to cut their salaries to less than that amount so they can continue to receive child benefit, which begins to be clawed back if one partner earns more than £50,000.
Do I need to obtain employee agreement?
You can install salary exchange as a default strategy for your employees so no paperwork is required, providing you have issued a communication notifying them of the change and detailed how they may opt out.
Does salary exchange require amends to contracts of employment?
You will be amending an employee’s contract of employment so if salary is reduced then this amounts to a change in their contractual terms. An employee’s agreement is needed but this can be covered by issuing an addendum of contract together with the right to opt out.
Our Salary exchange toolkit provides a review of your existing contract and addendum by an employment law specialist to ensure it is fit for purpose.
Can bonus and termination payments be exchanged?
Yes, bonus and termination payments can be exchanged. Special care must be taken to ensure that these payments are given up before any entitlement to them arises and with the personal tax consequences for the individual.
Any salary exchange arrangement must be planned and implemented carefully with full communication. Our Salary exchange toolkit provides full guidance on effectively communicating the new arrangement to your employees.
Does salary exchange work with all pensions?
Salary exchange arrangements will work with personal pension schemes and many of the master trust arrangements that have been set up for auto-enrolment, although you may need to check with your selected scheme.
For trust based schemes, some amendments may have to be made to the pension scheme's rules in order to implement salary exchange, and so the trustees' agreement may be necessary.
What is HMRC's position on salary exchange?
HMRC permits salary exchange, however, they will not pre-approve a scheme before it is set up and whilst it is not a requirement, it is good practice to seek approval once established to confirm the correct tax treatment of the arrangements. Our Salary exchange toolkit provides guidance on, and a template to do this.
Let us help you establish salary exchange for your business…
Our Salary exchange toolkit provides full guidance on implementing salary exchange in to your business.
Comprehensive list of considerations
Employee assessment advice
Full suite of employee communication templates
Amended contracts of employment
To discuss our Salary exchange toolkit in further detail, speak to one of our experts on: 01527 571 305