Partner Article

Nigel Reeves from Reeves Independent advises on salary sacrifice

What type of pension plan can salary exchange be used with?

It can be used with any type of UK registered pension plan – i.e. individual or group personal pension/stakeholder or occupational money purchase/final salary schemes. The main point to remember is that there must be an employer willing and able to make payments to the scheme after the exchange is made.

Can the self-employed use a salary exchange arrangement?

As there’s no employer to make a pension payment on their behalf, the self-employed cannot set up a salary exchange arrangement.

How can salary exchange be set up with a pension plan?

The employee exchanges an amount of salary that they would have otherwise paid to their pension plan. The employer then pays the amount exchanged to the pension plan as an employer payment. For example:

-Employee earns £20,000 gross yearly

-Employee currently pays 5% of salary to a pension plan – that’s £1,000 yearly

-Employee exchanges £1,000 of gross salary

-Employer pays this £1,000 (plus any employer payments) to the pension plan.

Can pension payments be increased just by using salary exchange?

Yes. Depending on how the NIC and tax savings generated are used, there are several options available. Our calculator can deal with the following four options:

None of the tax and NIC savings generated are used:

-Employer saves as they pay less NICs on a reduced salary.

-If it’s the current employee pension payment that’s being exchanged their take home pay increases as they are paying less tax and NICs, albeit on a reduced gross salary.

-Pension payments remain the same.

Employee take home pay remains the same:

-Employer saves as they pay less NICs on a reduced salary.

-If it’s the current employee pension payment that’s being exchanged, they can exchange slightly more so that their take home pay remains the same.

-The pension payment increases by the extra amount the employee exchanges.

The employer reinvests their NIC savings into the pension plan:

-Employer reinvests their NIC saving into the pension plan.

-If it’s the current employee pension payment that’s being exchanged their take home pay increases as they are paying less tax and NICs, albeit on a reduced gross salary.

-The pension payment increases by the amount of the NICs savings that the employer makes.

Employee take home pay remains the same and the employer reinvests their NIC savings into the pension plan:

-Employer reinvests their NIC saving into the pension plan.

-If it’s the current employee pension payment that’s being exchanged, they can exchange slightly more so that their take home pay remains the same.

-The pension payment increases by the extra amount the employee exchanges plus the amount of the NICs savings that the employer makes.

Higher rate and additional rate taxpayers can claim additional tax relief. Does this affect the salary exchange calculation?

This depends on whether the exchange is being set up in a personal pension/stakeholder pension plan or an occupational pension scheme:

Personal pension/stakeholder pension (relief at source)

In the vast majority of these plans, pension payments are deducted from net pay – i.e. after tax has been deducted. These pension payments are then grossed up by the pension provider at basic rate only. The amount that can be claimed back depends on the individual’s tax position and their total taxable earnings.

Occupational pension scheme (net pay arrangement)

In these schemes, payments are normally deducted from gross pay i.e. - before tax - this has the effect of giving full tax relief on any pension payments paid. Our calculator will show this where the individual is a higher rate or additional rate tax payer by showing the payment before the exchange as being deducted from gross pay.

Will HMRC restrict or remove salary exchange arrangements in the future?

Whilst there’s no straight answer to this as it’ll depend on Government attitudes going forward, HMRC have published guidance together with questions and answers on salary exchange. So it seems likely that at least in the short term, salary exchange will continue to be available.

How can any employer NIC savings generated through salary exchange be used?

The NIC savings the employer makes can be used in many ways. For example they can be used to provide other employee benefits, increase pension payments, shore up deficits in a defined benefit schemes, or the employer may simply keep the savings. Remember however that the actual amount of salary that the employee exchanges MUST be used to provide a non-cash benefit to the employee, such as childcare vouchers, or pension plan payments.

This was posted in Bdaily's Members' News section by Nigel Reeves .