Saving money for retirement is an essential topic of conversation for a large portion of the working population.
The good news is that in the UK specifically, employers can take advantage of various pension and savings schemes which are designed to help their employees to enhance their retirement savings.
One example is salary exchange (also known as Salary Sacrifice), a financial arrangement between employees and employers which can be used for pension schemes.
To give you more insight into what a salary exchange arrangement entails, we cover the following:
- The benefits of salary exchange
- Considerations for salary exchange
- How to set up a salary exchange agreement
But before we discuss any of the above, we would like to help you better understand a salary exchange arrangement and how it works.
What is a Salary Exchange Arrangement for Pensions?
Salary exchange is where the employee agrees to a contractual reduction in salary equivalent to their pension contribution.
The employer agrees to contribute on the employee’s behalf as part of the exchange. This generates tax and NI savings for the employee and a reduction in the total NI bill for the employer. Such savings can be used to enhance the value of the benefit, but this is not compulsory.
This scheme is particularly popular in the UK as it provides significant tax advantages both for the employee and the employer.
How Does Salary Exchange Work?
Let’s look at one basic example to give you an idea of how salary exchange works. Suppose you (as the employer) have an employee for whom you pay £37,000 annually.
If your employee agrees to a salary exchange arrangement, they give up a portion of their gross salary in exchange for a non-cash benefit, such as additional pension contributions.
For instance, if the employee agrees to exchange £3,400 per year for additional pension contributions, their new taxable yearly salary will become £33,600.
This reduction in gross salary means they’ll pay less in income tax and NI, while you, as the employer, will also save on NI.
Benefits of a Salary Exchange Arrangement
There are several benefits of using salary exchange for pension contributions, both for the employee and you as their employer. They include:
Tax Efficiency
Your employee’s taxable income will be lower by receiving a lower salary. As a result, they will pay less in income tax and National Insurance (NI), meaning their take-home pay will increase. This is especially important as employees face continued challenges with the cost of living.
By paying your employees a lower salary, they will pay less NI while you, as their employer, will also save on their NI contributions.
You can then use these savings as you see fit. You may decide to re-invest this saving by enhancing your benefits offering or offset against the increase in employers’ NI rates.
Considerations for Salary Exchange Arrangements
Despite being one of the most popular strategies for effective financial planning, there are several considerations for salary exchange arrangements. They include:
Effect on Other Salary-related Benefits
Most salary-related benefits, such as bonuses, overtime, and group life assurance, are calculated based on the employee’s gross salary. However, employers can take action to ensure that these benefits are not reduced.
Ensuring Salary Does Not Fall Below National Minimum Wage
Employers must ensure that employees’ post-exchange salary remains above the legal threshold to comply with employment laws such as the national minimum and Living wage.
Statutory Payments
Employers should consider statutory benefits such as maternity, sick, and redundancy pay when designing a salary exchange arrangement, as these payments are calculated based on the employee’s gross salary.
Employment Law
Changing to a salary exchange arrangement for existing employees could potentially require a change to their terms of employment. This can be included as part of the communication exercise.
Setting Up a Salary Exchange Arrangement
Implementing a salary exchange arrangement for your pension scheme requires careful planning and clear communication between you as the employer and your employees.
Below is a brief overview of the steps that Broadstone can assist you with when setting up a salary exchange arrangement to ensure compliance and maximisation of the benefits for all parties involved:
- Assess suitability (employee eligibility, employer cost savings, impact on payroll, etc.)
- Review existing scheme rules and employee communications
- Review contracts of employment
- Communicate the details of the arrangement to your employees
- Update your payroll and HR systems
- Review and monitor the scheme
Get More Advice on Salary Exchange
If you are an employer and would like more advice on salary exchange, do not hesitate to contact us today.
Once we receive your enquiry, we will contact you and provide you with expert guidance tailored to your organisation’s needs.
If you would like to broaden your knowledge around pensions, you should also tune in every week and listen to our Pension in 10 podcasts hosted by Broadstone’s Head of Policy, David Brooks.
