How can Salary Exchange Save you Money?

As recently as the March 2016 budget there was a real groundswell of opinion that the opportunity to make pension contributions via salary exchange (also known as salary sacrifice) was going to be under attack and removed. One quick check on Google will show that it has been almost an annual discussion point in the financial press – ‘the demise of salary exchange in the next budget’.

National Insurance Savings for Employers

Thankfully, this advantageous method of making pension contributions escaped the axe. The government actually helped alleviate future fears by stating their acceptance of the salary sacrifice method for making pension contributions. For companies across the country already using salary exchange, this will have been welcome news because they won’t have to amend contracts of employment, as well as from a financial point of view.

By using this method, companies save 13.8% by no longer having to pay national insurance on any amounts exchanged. Some employers keep this saving to help budgets or provide other benefits whilst others further enhance the pension contributions by rebating part or all of the saving. The choice is theirs and as much as we all know what option employees hope they make, there is no right or wrong answer.

Tax Benefits for Employees

The financial benefits for individuals vary depending on their tax position. It is very important to understand the tax implications for individuals as no employee should be entering into an exchange agreement unless it benefits them.

In a nutshell, salary exchange involves giving up (exchanging) salary and receiving a non-cash benefit of equivalent value in its place. In the case of pension, the non-cash benefit is the company pension contribution.

We tend to use a simplified way of explaining the benefit as many employees will follow a pounds and pence example rather than table after table describing tax and national insurance. For a basic rate tax payer, the net cost of traditionally contributing £100 will be £80 net.  In short, it costs them £80 to pay in £100. Using salary exchange, they no longer pay national insurance at 12% on the value they have exchanged, this results in a new net cost of £68 to contribute the same £100.

Higher rate tax payers only pay national insurance at 2% on their earnings above £43,000, rather than the 12%, so in effect they can only benefit by that amount. Often for these individuals it is the removal of the tax reclaim burden that is viewed as a major advantage of using salary exchange. Effectively, it would cost them £58 to pay in £100 and they would no longer need to reclaim the difference between basic and higher rate tax from the revenue.

Avoid Salary Sacrifice Pitfalls

It is not all simple and straightforward though and there is a lot to consider when implementing salary exchange including national minimum wage, effect on state benefits, age of employees and tax thresholds. For any company considering using this benefit it is vital to get guidance to avoid any pitfalls.

Other salary exchange schemes that fall outwith pensions, such as childcare vouchers and cycle to work, are not off the hook and are likely to come under scrutiny in a forthcoming review. However, the great news is that the option to use salary exchange for pension deductions is alive and well and should remain for the foreseeable future… at least until a new chancellor comes along and thinks differently!