Pension salary exchange was initially introduced in the 1970s, when employers were searching for cost-effective ways to reward their employees. Simon Juffs explains why now more that ever, employers should be looking at pension salary exchange.
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Thanks to the introduction of auto-enrolment back in 2012, all UK employers have a pension scheme in place and with the anticipated upcoming changes for auto-enrolment, the business case for introducing salary exchange is stronger than ever. However, according to surprising research from Aegon, a leading provider of pensions to businesses in the UK, only around 50% of employers use a salary exchange arrangement for their pension.

Furthermore, according to a recent report by PensionBee, an online pension provider, approximately 80% of higher rate taxpayers eligible to claim tax relief through their Self-Assessment tax returns are failing to do so. An estimated 54% of additional rate taxpayers are also inadvertently leaving tens of millions of pounds to HMRC.

By simply changing the method you pay pension contributions, significant employee and employer savings can be achieved. It’s never too late to seek advice on how to save money using this option.

What is pension salary exchange?

Pension salary exchange (also known as Salary Sacrifice or SMART Pensions) is a tax efficient arrangement that can be used for pension contributions to reduce both the employee’s and employer’s National Insurance Contributions (NICs). The tax savings made are made on each payroll cycle, and you don’t need to establish a new workplace pension scheme – your existing one can be used.

How it works

An employee agrees to a reduction in pay equivalent to the amount of their gross pension contribution. Pay reviews and any salary related benefits are, however, still based on their original salary. In return, the employer pays the exchanged amount to the pension plan, in addition to their regular employer contribution. As a result, the member and employer now pay NICs on the member’s reduced pay after these contributions have been deducted. Employers' pay NICs on an employee’s salary at 13.8% and employees pay it at 12% (up to £50,000) or 2% (over £50,000).

Implementing salary exchange

Implementing pension salary exchange requires a change in employees’ terms and conditions of employment. Employers therefore need to be able to demonstrate that employees fully understand and consent to the change, for it to be valid in HMRC’s eyes.

It's therefore vital that the documentation to enact the change is correct and that your payroll team understand the changes.

Virtually all payroll software packages have functionality for pension salary exchange. In addition, while not essential, HMRC clearance for the salary exchange arrangement can be obtained for full peace of mind.

Historically, the implementation of pension salary exchange has been a form filling exercise. In recent years though, the process can be implemented through ‘negative affirmation’ which speeds up the whole process, with take up typically now around 95%.

If an employer already has a pension salary exchange arrangement using paper based joining, research shows that take up is likely to be significantly lower than 95%. By revisiting this area and simplifying the joining process by moving to negative affirmation, employers can generate significant additional savings.

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Example of savings

The following illustrations provide an indication of the annual NICs savings available. It shows, based on salaries of £25,000, £40,000 and £60,000 per annum and pension contributions of 5%, the savings generated by using salary exchange.

For example, for an employer with 150 employees on an average salary of £25,000, would potentially save over £25,000 per annum for the business. 

Salary Per Annum

£25,000

Salary Per Annum

£40,000

Salary Per Annum

£60,000

Contribution Percentage

5%

Contribution Percentage

5%

Contribution Percentage

5%

Contribution Amount Per Annum

£1,250

Contribution Amount Per Annum

£2,000

Contribution Amount Per Annum

£3,000

Employee’s NIC Rate

12.0%

Employee’s NIC Rate

12.0%

Employee’s NIC Rate

2.0%

Employee Savings*

£150

Employee Savings

£240

Employee Savings

£60

Employer Savings**

£172.50

Employer Savings

£276

Employer Savings

£414

* Calculated as Employee’s NI Rate x Contribution amount per annum

** Calculated at Employer NI rate of 13.8% x Contribution amount per annum

Next steps

Times are tough and employers may be searching for ways to improve their benefits offering without incurring additional costs. Pension salary exchange can be a great benefit for your employees and can help your business create a budget for additional new benefits. However, pension salary exchange may not be right for all employees, particularly the lower paid, which is why it's crucial to take advise regarding the suitability for your workforce.

We can help advise employers on how best to implement pension salary exchange based upon their own unique situation. Salary exchange is not always an easy concept to understand, but we can go through the scheme design options and provide all the information an employer needs to make a fully informed decision.

For more insight and guidance, get in touch with Simon Juffs