Using salary exchange to help mitigate the increase in National Insurance contributions

In April 2022, the Government increased the National Insurance contribution percentages due on earnings over the relevant thresholds. In this case study we look at how salary exchange could help employers to mitigate the cost of the increase.

What are the changes?

On 6 April 2022, the Government introduced a temporary increase to National Insurance contributions.

This 1.25% increase means:

  • Class 1A and 1B employers will pay 15.05%, up from 13.8%.
  • Class 1 employees earning below National Insurance contributions upper earnings limit will pay 13.25%, up from 12.00%.
  • Class 1 employees earning above the National Insurance contributions upper earnings limit will pay 3.25%, up from 2%.

You can find out more information on the National Insurance classes at National Insurance: National Insurance classes - GOV.UK (www.gov.uk) 

From July 2022, the Government increased the primary threshold for employees from £9,880 to £12,570.

Changes from 6 April 2023

From 6 April 2023 this increase is being replaced by a new tax named the Health and Social Care Levy which will apply to both employers and employees, including those above the state pension age, at a rate of 1.25% each. The levy will have the same thresholds and requirements as the qualifying National Insurance contributions.

How can salary exchange help mitigate the increase?

Employer case study

Let’s take a look at an employer with an average wage bill of £3,000,000 a year. We’ve based our example on 100 employees with an average salary of £30,000. 

Tax yearTotal employer National Insurance contributions bill
2021/22 £292,008
2022/23 £314,545
Increase: £22,537

Their current scheme is set up using relief at source and their employees are paying £150,000 (£3,000,000 x 5%) in pension contributions. This is based on employees paying a 5% contribution. 

By setting up their pension using salary exchange, the employer could save £22,575 (£150,000 x 15.05%) a year on their National Insurance contributions. This means the employer can mitigate the full amount of the increase through adopting salary exchange.

Employee case study

Let’s see how this works for an employee. We’ve based this example on an employee who lives in England, who earns £30,000 a year, has a personal allowance of £12,570 and is paying a 5% pension contribution. The employer is not reinvesting the National Insurance savings into the workplace pension scheme.  

Monthly - 2021/22 tax year
Gross pay Income tax National Insurance Pension Take home pay
£2,500 £290.50 £204.32 £100 £1,905.18
Monthly - 6 July 2022/5 April 2023
Gross pay Income tax National Insurance Pension Take home pay
£2,500 £290.50 £192.39 £100 £1,917.11
Increase in take home pay £11.93

Using salary exchange

Monthly - 6 July 2022/5 April 2023
Gross pay Income tax National Insurance Pension Take home pay
£2,375 £265.50 £175.83 £0 £1,933.67

Before salary exchange the employee was paying a pension contribution of £100 a month through relief at source. When this is paid into the pension plan it is grossed up to £125. Using salary exchange the employee sacrifices £125 a month reducing their salary from £2,500 to £2,375 a month.

By contributing to their pension through salary exchange their take home pay will increase by £28.49 from July 2022 (£1,933.67 - £1,905.18). Between 6 April and 5 July 2022 their take home pay would have reduced by £1.28 a month.

Further information 

Salary Exchange - frequently asked questions - Royal London for advisers

How to get 61.5% tax relief on pension contributions - Royal London for advisers

60% tax relief on pension contributions - Royal London for advisers

National Insurance rates and earnings limits from 6 April 2016 - Royal London for advisers

 

Notes

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.

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