Net pay summary | Before salary exchange Article continues after advert | David, after salary exchange | Tina, after salary exchange |
Annual salary (gross) | £40,000 | £38,000 | £37,603 |
Total income tax | £5,486 | £5,086 | £5,007 |
Total national insurance | £3,634 | £3,369 | £3,317 |
Employee pension (net) | £1,600 | £0 | £0 |
Total net take-home pay | £29,280 | £29,585 | £29,280 |
Increase in take-home pay | £265 | £0 | |
Increase in pension | £0 | £397 |
Employer NI | ||
NI savings | £301 | £361 |
NI saving to pension | £301 | £361 |
Pension contribution | |||
Employee (gross) | £2,000 | £0 | £0 |
Employer (gross) | £2,000 | £4,301 | £4,758 |
Total pension | £4,000 | £4,301 | £4,758 |
Total pension increase | £301 | £758 | |
*Scottish Widows Salary Exchange Calculator 14/09/2022. These amounts will change after 06/11/2022 due to the removal of the additional 1.25% NI contribution.
Possible drawbacks
Although salary exchange can provide valuable benefits for employers and employees, it may not always be a suitable option. It’s important that both employer and employee are aware that they are entering into a legally binding contract and that they have considered what a reduction in gross salary will mean for them.
They are not suitable for employees who:
- Earn under the personal allowance (currently £12,570) as they would benefit more from paying personal contributions to a relief at source scheme where they get 20 per cent tax relief, despite paying no income tax;
- Earn below the primary earnings threshold (employee) and secondary (employer) NI thresholds as they do not pay NI, so will not benefit from taking part in salary exchange;
- Would be taken below the minimum wage if they took part in salary exchange; or
- Earn above the tapered annual allowance threshold income limit, as they may be disadvantaged by salary exchange, but may benefit from paying personal contributions.
There can sometimes be drawbacks for employees entering a salary exchange arrangement.
For example, the employee might not be able to revert to their old (pre-exchange) salary if personal circumstances change. The employer would have to agree to a further change to the employee's contract of employment.
The employee may not be able to borrow as much following their change in salary. This could affect the levels of mortgage, personal loan or credit card limit they can get. However, some lenders will base their calculations on the notional (pre-exchange) salary.
Salary exchange may also affect entitlement to some state benefits and other salary-related elements of the employee’s employment package – such as death-in-service cover, contractual pension contributions, defined benefit pensions, PHI cover, overtime pay or future salary rises.
However, many employers will base salary-related elements of their employment package on a notional (pre-exchange) salary to avoid this.
There can be drawbacks for the employer too, for example, extra administration and retaining a notional or reference salary for employees. A notional or reference salary is the amount of salary before any salary exchange took place.
If an employee is off work for a long period of time, the employer may have to continue paying the pension contributions in line with the contract of employment, even if the employee is not receiving sick pay or maternity pay.
Setting up salary exchange schemes
There are certain things that need to be in place before you implement salary exchange schemes.
As the employee’s contract of employment must be altered and formally agreed, you need to follow a clear communication process, including formal consultation periods. The employee must sign to confirm that they agree with the proposed changes, before any can be made.
Pension providers will give you a lot of support, including exchange calculators, sample letters and suggested communication processes. You will also find more information in the HMRC handbook on their more detailed requirements.
The introduction of a salary exchange scheme may result in alterations to payroll administration and the layout of payslips. Quite often you will need to work with the payroll providers to ensure this is done correctly and that employer contributions are paid to the pension providers.
