Helping Employers Navigate Rising NI Costs: The Role of Salary Exchange

Craig Muir outlines a strategic approach to navigating the upcoming increase in employer National Insurance contributions, with specific reference to salary exchange.

This article was originally published by Investment Life & Pensions Moneyfacts Magazine and is shared here with their permission.

Chancellor Rachel Reeves announced in the October Budget 2024 that employer National Insurance contributions will increase from 13.8% to 15% with effect from 6 April 2025. Additionally, the threshold for paying employers’ National Insurance (NI) contributions will reduce from £9,100 to £5,000. This change alone will result in an increase in employer National Insurance contributions of £6,151 per employee per year. It’s important to remember that, as National Insurance is not a devolved tax, this increase applies to employers across the UK.

However, this increase is offset by the Employment Allowance, which will rise from £5,000 for employers with an NI bill less than £100k, to £10,500. This allowance will be available to all eligible employers from 6 April 2025, reducing their overall NI bill.

Employer concerns and strategic responses

Royal London research² post-the October Budget shows that employers are concerned about the increased employment costs, the impact on business growth, and the expectation of reduced profits. Employers have indicated that they may look to reduce direct employment costs, which could involve recruitment freezes or redundancies. Alongside this, they said reviewing where there may be opportunities for tax savings will be important.

Employers have also indicated that they may reduce their employer pension contributions, subject to them meeting their automatic enrolment (AE) minimum contribution requirements and stop any increase to their contribution. For employers currently using salary exchange, they may reduce the 100% redirection of National Insurance savings currently being added to their employees’ pensions pots. Reducing employer pension contributions will result in less going into an employee’s pension pot and less being available to invest in UK infrastructure via the pot. And, ultimately, a lower income when the employee takes their benefits.

Mitigating the impact with pension contributions

Employers do not pay NI on their employees’ pension contributions. And if they use salary exchange, they have the option of passing this saving on to their employees, which would increase their employees’ pension pot and, in turn, may help with recruitment and retention. This may help shift the conversation with employees solely on the headline salary to considering the total remuneration package.

This is especially true if some of the employer NI saving is used to provide employee benefits, whether that is additional pension contributions or some other form of benefit, such as group income or critical illness cover. Alternatively, employers could keep the savings for themselves or consider a combination, perhaps passing a percentage on to employees while retaining the remainder for themselves.

With salary exchange, there’s a contractual agreement to reduce an employee’s headline salary. This saves both employee and employer NI on the salary no longer paid to the employee. The employer then pays both their own and the employee’s pension contribution as an employer pension contribution.

The role of advisers

For advisers, there is an education piece for employers on their books explaining what’s happening to their NI contributions and how salary exchange can be used to mitigate their increase in NI costs.

If employers decide to decrease their pension contributions, again subject to minimum AE requirements, or perhaps to reduce the amount of NI rebated into their employees’ plans, this will reduce the pension pot for their employees. Therefore, any clients who have targeted a certain level of income in retirement will need to revisit their plans, and their contributions will need to increase if they wish to achieve the same level of income as they had planned. If they don’t, their income will be reduced.

Case study

Let’s use a case study to bring the benefits of salary exchange to life.

We’ll assume there are 100 employees in an example pension scheme with an average salary of £35,000. The pension contributions are 5% employee pension contribution (including 1% tax relief) and 3% employer contribution. The pension contribution is based on total earnings, so from pound one and not based on qualifying earnings.

We’ll focus on one individual employee, Sam, and his position pre & post salary exchange, then consider the employer’s position pre and post, and then at the overall position (see tables below).

Before salary exchange, Sam’s headline salary is £35K, he makes his own pension contribution £1,400 net (£1,750 gross) and has a take home salary of £27,320.

After salary exchange, his headline salary is lower, he makes no pensions contribution as his employer now makes it all on his behalf, and his take home salary is still £27,320.

Sam’s take home salary hasn’t changed, so he hasn’t seen any real benefit so far. To see this, we need to look at the employers’ position.

By the employer paying Sam less salary, Sam makes an NI saving and so does the employer. In our example, Sam is re-directing all his NI savings to his pension, and the employer is re-directing half of their NI savings to Sam’s pension contribution and keeping the other half for themselves, which they’re
quite entitled to do. The employer could keep all their NI savings or redirect all their savings and there are a few other options too.

Sam’s headline salary has gone down, but the employer’s pension contribution has gone from £1,050 per annum before salary exchange to £3,129 per annum after. This is because they still pay their £1,050 contribution, plus all of Sam’s contribution, plus all of Sam’s NI savings, plus half of their employer’s NI saving, all into Sam’s pension. Even with the additional pension contribution from the employer, the cost of employing Sam for the employer has reduced by £134 per annum.

Sam now has £3,129 per annum going into his pension, which is £329 extra each year, for the same take home pay he received when making a pension contribution without salary exchange.

This is a key point. It doesn’t make the pension contribution free. You just get more bang for your buck.

If the employer had 100 Sams in the scheme, that would mean a saving, every year, for the employer of £13,400 – not taking into account any wage increases, which would deliver an increased NI saving.