Salary exchange, which can produce tax and National Insurance (NI) savings when employees give up entitlement to a proportion of salary in exchange for receiving certain benefits from their employer, can be a very attractive proposition for many companies.
It can work particularly well for major employee benefits that were specifically exempted from adverse tax changes implemented in April 2017, namely pension contributions (including additional death-in-service cover under a flex scheme), employer-funded regulated individual pension advice, Childcare Voucher schemes and Cycle to Work schemes.
Indeed, salary exchange for these benefits has gained a whole new momentum since the changes because the exemptions have dispelled long-standing fears that the Chancellor was about to clamp down on usage of the approach in conjunction with them.
The ability to save 13.8% in NI on employees’ pension contributions has also come into even sharper focus since total minimum auto-enrolment contribution levels increased to 8% in April 2019 – of which employers must pay at least 3%.
Nevertheless, there are still some potential downsides of salary exchange that employers must consider before taking the plunge and, from what we have learned from auditing new clients, it is clear that many have failed to do so.
It is easy to forget that those who exchange some of their salary in return for employee benefits are effectively lowering their income, and this can have particular repercussions for low earners.
It is especially important to ensure that the element of salary being exchanged does not take any employees below the legal minimum wage, and this is an issue that has become even more prominent since the announcement of imminent increases.
With effect from April 1st this year the National Living Wage, which applies to those aged over 25, is increasing from £8.21 to £8.72 per hour. Younger workers who receive the National Minimum Wage will also enjoy increases of between 4.6% and 6.5%, depending on their age.
Anyone whose salary is reduced below the legal minimum must not be allowed to use salary exchange, otherwise their employer will face fines from HMRC and will have to recompense employees. For this reason, Chase de Vere normally includes a pay protection limit in our salary exchange document, advising employers of the level they can’t go below.
Employers should also be alert to the fact that salary exchange can prove costly during paid maternity leave. This is because it is illegal for them to make deductions from Statutory Maternity Pay yet they are required to continue to make full pre-maternity rate employer pension contributions.
Furthermore, salary reductions can result in lower life cover and mortgage borrowing levels – because they tend to be worked out as multiples of salary.
A further really common problem that we are coming across is that salary exchange arrangements are failing to have the correct documentation in place. Unless a proper agreement has been signed by both employer and employee the scheme is not valid.
We find that this can be a particular issue with pensions, where providers tend not to be as good as Childcare Voucher or Cycle to Work scheme providers at issuing proper agreements.
The considerable advantages of salary exchange can of course outweigh these potential pitfalls, although they won’t necessarily do so in every case. So, there is a lot to be said for taking professional advice from an expert intermediary on the subject.
As well as discussing the pros and cons of salary exchange with you, Chase de Vere can advise on which employee benefits the approach might be most suitable for in your particular organisation, depending on your budget and objectives and the make-up of your workforce.
The Financial Conduct Authority does not regulate Tax Advice
Content correct at time of writing and is intended for general information only and should not be construed as advice.