The increase in the National Living Wage on April 1st this year from £9.50 to £10.42 an hour (for those aged 23 and over) obviously represents better news for employees than for employers, and not just because the latter will be incurring significant additional costs.
There are also technical and administrative considerations to address, and one of the most significant of these concerns the way the rise will affect companies that use salary exchange for their pension schemes.
This issue is currently highly topical, and we have been getting numerous enquiries from clients asking how it could impact them and what action they might need to take.
Legal risk
The salary exchange process, which works by employees agreeing to give up a proportion of their salary in return for receiving pension contributions from their employer, can realise significant tax savings.
Because employees have a lower overall salary, they gain from paying less NI and Income Tax . Employers can also save on NI contributions, and this can further benefit employees because part of this saving is often used to enhance employee pension contributions.
However, there is a danger that this reduction of salary, which must be embedded in an employee’s terms and conditions of employment, could reduce the earnings of lower-paid employees below the National Minimum Wage (under 23s) or National Living Wage (23 and over).
Although such a breach may be inadvertent, it will still constitute breaking the law, and could result in incurring penalties if certain conditions haven’t been met. It will also create administrative hassle because any underpayments will have to be repaid as soon as possible.
Furthermore, it could impact on employees’ entitlements to State Benefits – an issue which has traditionally made the salary exchange approach unsuitable for some workforces with very low-paid workers.
The Payment Protection safeguard
In order to maximise take-up rates, and therefore increase both employer and employee savings, most employers use salary exchange for pension schemes as a default position – meaning that contributions will automatically be deducted on a salary exchange basis unless an employee specifically opts out.
This is the approach we recommend for virtually all our clients because it is clearly the best fit with auto-enrolment. If employees are offered a choice and sent loads of information asking if they want to do salary exchange, few will take the time to read or understand it. So, take-up rates will be very low.
As part of this default position, we recommend that all clients using salary exchange have a Payment Protection Limit to safeguard against breaching the National Minimum/Living Wage. Employees whose salaries fall below this limit are not enrolled but all others automatically are.
However, the impending change in the National Minimum/Living Wage means that we will be changing this Payment Protection Limit. For existing clients we will be making this tweak as part of their regular review but the issue could act as a useful trigger for other employers to have their scheme reviewed if they haven’t done so for some time.
Other considerations
Whilst reviewing the Payment Protection Limit, we can also look at other considerations such as whether salary exchange is being adequately communicated and whether sickness and parental leave policies are compliant with it. We can advise as well on how best to spend any employer NI savings realised and can check that salary exchange has been correctly set up on the payslip.
Additionally, it is worth having an expert intermediary look at how salary exchange might be impacting on other benefits. For example, group life cover needs to be expressed as multiples of pre-salary-exchange salary, not post-salary-exchange salary. Failure to notify the insurer will result in a post-salary-exchange basis being used because that is the information shown on the payslip.
Other employee benefits that can be used successfully in conjunction with salary exchange, most notably childcare vouchers and Cycle to Work schemes, also need to be examined for Payment Protection Limits and other issues.
If you would like to find out more about how Chase de Vere can help you by reviewing your salary exchange arrangements or you have any questions about salary exchange, then please don’t hesitate to contact us.
Content is correct at the time of writing and is intended for general information only and should not be construed as advice.