A: In basic terms:
Since April 2017 the income tax and National Insurance benefits of salary exchange schemes will be removed for some arrangements. This change excluded arrangements in respect of pensions as well as advice, childcare, Cycle to Work and ultra-low emission cars. Arrangements in place before April 2017 were protected until April 2018 and arrangements for cars, accommodation and school fees are protected until April 2021.
More information on the changes can be found in Salary sacrifice - GOV.UK
A: It can be used with any type of UK registered pension plan, such as 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 contributions to the scheme after the exchange is made.
A: As there's no employer to make a pension contribution on their behalf, the self-employed cannot set up a salary exchange arrangement.
A: Yes. Depending on how the NIC and tax savings generated are used, there are several ways available. Our calculator can demonstrate the following four examples for someone who was paying a member contribution but opts to use salary exchange:
1. None of the tax and NIC savings generated are reinvested into the pension plan:
2. The employer decides to keep the NIC savings rather than reinvesting them into the pension plan. The employees reinvest their income tax and NIC savings into the pension plan:
3. The employer reinvests their NIC savings into the pension plan. The employees keep their savings rather than reinvest them into the pension plan:
4. The employer will reinvest their NIC saving and the employees will reinvest their NICs and income tax savings into the pension plan:
A: No, the salary exchange calculation and tax and National Insurance saving are not affected.
However, if the employee is a higher or additional rate-tax payer and they were contributing to a personal or stakeholder pension they would pay their own contributions net of basic rate tax. They would then claim any higher and additional tax relief through their self-assessment tax return. As the contribution is now being paid by salary exchange (that is, by the employer) no income tax is deducted as the salary has been given up. So they effectively get their tax relief immediately and do not have to claim it through their tax return.
If they are members of an occupational pension scheme, member contributions are paid before income tax is deducted. There is no need to claim the higher and additional rate tax relief through their tax return. This is very similar to salary exchange but salary exchange also saves on National Insurance contributions.
A: 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 contributions, shore up deficits in a defined benefit scheme, or the employer may simply keep the savings. Remember, 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 contributions to a pension plan.
A: No, salary exchange constitutes a change to an employee's contract of employment, it's not within the remit of HMRC and they do not have to be advised.
However HMRC is concerned that tax and NICs are deducted correctly. Employers have the option to contact HMRC if they want to make sure that they're deducting tax and National Insurance contributions correctly after the salary exchange arrangement is in place. Details of how they can do this can be found in HMRCs: Salary Sacrifice and the effects on PAYE.
A: Yes it can normally be altered, for example, if someone opts out of an automatic enrolment scheme with salary exchange. For any other circumstances it depends on how the agreement has been set up.
A: Yes, salary exchange can affect certain employer, state and other benefits, some of which are listed below - note that this list is not exhaustive. The impact on benefits can however be mitigated in certain circumstances.
More information on how salary exchange can affect benefits can be found in our guide to salary exchange and guide for employees.
Although salary exchange is a reduction in gross salary, the agreement can be constructed so that salary increases, bonuses and overtime for example are based on the salary before the exchange. This is commonly known as 'notional' or 'shadow' pay.
Mortgage and other lenders may base the amount that they're willing to lend on either a multiple of salary or affordability. Employers can provide lenders with details of an employee's pre-exchanged salary however this may not be accepted. Employees considering borrowing should therefore discuss this with their lender.
Entitlement to both the basic and new State Pension is based on the number of 'qualifying years' in an individual's working life rather than the amount of NI contributions. For a year to count as a qualifying year earnings need to be above the Lower Earnings Limit (LEL) care should be taken not to salary exchange below that level.
The level of entitlement to additional State Pension (S2P) was based on the level of earnings so using salary exchange would have affected the level of S2P benefits.
SMP/SAP are based on gross earnings that are subject to Class 1 NICs and tax. As these earnings will reduce as a result of salary exchange, there'll be an impact on SMP/SAP and they may also reduce.
If the employer operates an occupational Maternity or Adoption Pay policy, they may increase payments up to or above the pre exchange statutory amount to ensure the individual does not lose out.
If earnings are reduced to less than low earnings limit (LEL), there's no entitlement to SPP.
SSP is a work-related payment which employees are entitled to by law and is not connected to their contract of employment.
If earnings fall below LEL then there's no right to receive SSP. If this happens employees may still be entitled to Income Support or Employment and support allowance, if they meet the qualifying conditions.
If the employer operates an occupational sick pay scheme, sick pay could still be paid through that scheme even if earnings are less than LEL to ensure employees are not worse off.
Repayments of student loans are triggered where earnings are above a certain level, which will depend on when the loan was taken out. If a salary exchange reduces earnings to below this threshold, repayments may reduce or stop. This may mean that it'll take longer to repay any student loan.
The Working Tax Credit (WTC) and Child Tax Credit (CTC) were introduced in April 2003 to help families on middle incomes. The amount of WTC depends on several factors including the number of hours worked, how many children the employee has and the amount of eligible childcare costs.
Working Tax Credit is calculated on actual taxable earnings, so if these are reduced by a salary sacrifice, an individual's WTC entitlement may increase.
A: Until June 2012, salary exchange for employer pension contributions had to be for a set period but since then they can be ended at any time (if the agreement allows).
A: In general, no. An individual cannot exchange salary so that their remaining salary is below the national minimum wage (NML) or national living wage (NLW).
The exception to this is individuals who are directors. The NMW/NLW does not apply to directors so they could if they chose to exchange their whole salary.
A: No, HMRC will not give any guidance on the salary exchange agreement wording.
The agreement is part of the employment contract, so the best people to ask for assistance would be the lawyer or employment law specialists that drafted the contract of employment the employer uses with their staff.
Pension providers may provide example templates but as employment contracts are usually company specific it make sense to have a lawyer or employment law specialists check the wording.
A: Unless the agreement is written in such a way that it stops at certain events such as parental leave or when long term sick leave starts the employer will have to continue making the payments while the individual is being paid by the employer.
Remember that under the rules for parental leave the employer is required to maintain their pension contributions at the level they were before the individual started parental leave. They should continue until paid parental leave ends.
A: As far as the auto enrolment rules are concerned, you must use the post exchange salary to calculate whether minimum contributions have been met.
This is best covered by an example:
Pre exchange salary is £50,000. Contributions are 3% employer and 5% employee (including tax relief). The employee wants to use salary exchange to make their £2,500 contribution. Their post exchange salary is therefore £47,500, meaning that the actual employer contribution of £4,000 (£1,500 + £2,500) represents 8.42% of the £47,500 salary, not 8%.
It therefore needs a bit of maths to calculate in advance what level of sacrifice would result in the minimum contribution being met when measured against the post exchange salary. Most providers require the minimum to be based on the pre-exchange salary, accepting that this results in the contribution being more than the minimum required when measured against the post exchange salary.
In the above example, the employer is making the minimum contribution and the employee is using salary exchange to make the employee contribution. It's unlikely that providers and/or the Pensions Regulator will allow the total required contribution to be funded by employee salary exchange. The employee must always have the option to go for a conventional employer/employee contribution basis and there must be no coercion into using salary exchange.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.