How does the salary exchange pension scheme work?

Salary exchange pension scheme is a great way in which employers and employees can save tax and national insurance contributions.

In essence a salary exchange pension scheme works when an employee gives up part of their salary in exchange for an employer contribution, saving both the employee and employer 13.25% and 15.05% national insurance.

There are HR and tax implications of putting a salary sacrifice scheme in place, so we always recommend taking advice before implementing this kind of scheme.

It it not all doom and gloom through… the Spotlight team have plenty of experience in putting salary sacrifice schemes in place so can guide you through the process. Here we explain more!

How does salary exchange work?

A salary sacrifice or salary exchange works by swapping part of an employee’s gross salary for employer pension contributions.

The same amount is paid into employees pension schemes, but instead of both the employer and employees making contributions, only employers pay into the workplace pensions.

So, for example let’s say Jack is an employee with a gross salary of £35,000. He would be making employee pension contributions of £1,438 into the workplace pension scheme.

Under the salary sacrifice arrangement, Jack would sacrifice £1,438 of his gross salary for an employer pension contribution.

Whilst Jack would have a reduced salary of £33,562, the employer contributions paid directly into the workplace pension would increase by £1,438.

Who benefits from salary sacrifice?

The benefits of the salary sacrifice is that as the employee’s salary is reduced, the employee saves both tax and national insurance contributions.**

From an employers perspective, NI contributions are saved as as the employee is being paid a lower salary.

How does a salary exchange pension work?

Using Jack as the employee example above, based on an annual salary of £35,000 and making workplace pension contributions of £862.80, their employer will pay £1,438.00 in employer pension contributions.

The table below demonstrates how the salary sacrifice would work, and how Jack can save £198.44 a year in national insurance contributions:

Let take another employee example, this time Steph with a salary of £60,000.

Before any salary exchange, Steph would be making £2,201.50 of pension contributions and her employer would be making contributions of £1,320.90 into her pension pot.

Using the table below demonstrates how the salary sacrifice works.

This would save Steph £291.70 in national insurance each year, and see her gain tax savings of £440.30.

How does salary sacrifice affect my take home pay?

As all employees would be making less national insurance contributions and some paying less income tax, take home pay would increase.

In the examples above, Jack would receive an additional £16.53 per month and Steph £61.00.

Is it worth it?

There are a number of factors to consider when assessing whether it is worth implementing a salary sacrifice scheme.

The main deciding factors will be the both the tax and national insurance contribution savings, however, you should also consider:

1. HR implication as the salary sacrifice scheme would change the terms of each employee’s employment contract. To join the scheme, each employee agrees to the change and the employee’s contract needs to reflect the change in both salary and non cash benefits.
2. Not all employees may join the scheme as some may choose to opt out .
3. As an employee’s salary falls under the scheme, this could impact national minimum wage legislation.
4. A salary sacrifice scheme can impact statutory maternity pay, which is based on average salary calculations over the qualifying period.

FAQs

Do I need to tell HMRC about salary sacrifice?

You do not need to tell HMRC about salary sacrifice, but there is guidance that HMRC have in place to protect both employees and employers when putting a salary sacrifice arrangement in place.

What is the difference between salary sacrifice and salary pension?

Under salary sacrifice, only an employer would pay into an employees pension pot. Whereas under salary pension through auto enrolment, both employees and employers pay in.

The amount paid into the scheme is the same, but using salary sacrifice results in less tax and national insurance being paid.

Does salary sacrifice affect tax return?

The tax return will show lower earnings due to the salary exchange, but this will be reported on an employee’s P60 at the end of the tax year.

Does salary sacrifice reduce pensionable pay?

Salary sacrifice does reduce pensionable pay, however as only employers pay into the pension pot, contributions are not based on pensionable pay.

How much salary is sacrificed?

This is down to the individual employee and the salary sacrifice scheme that an employer offers. The minimum would be the value of the employee contributions for the scheme to be cost effective, however an employee could sacrifice more salary it is beneficial to do so.

Does salary sacrifice only apply to pension contributions?

Salary sacrifice does not only apply to pension contributions, HMRC’s definition of a salary sacrifice arrangement is:

“A salary sacrifice arrangement is an agreement to reduce an employee’s entitlement to cash pay, usually in return for a non-cash benefit.”

Non-cash benefits can include a company car, life cover, childcare vouchers or child care costs, and medical insurance. However, some of these benefits attract tax and national insurance so are not as efficient.

For more information on salary sacrifice schemes, tax and national insurance, contact us at Spotlight Accounting today!

**where tax relief is not given at source and where employees are a higher rate payer

Please note tax and national insurance rates quoted are for the 2022/23 Tax year.