SALARY EXCHANGE
ADVISER GUIDE
This material is for use by UK Financial Advisers only.
It is not intended for onward transmission to private customers
and should not be relied upon by any other person.
E02223890_47786_0417.indd 1
07/03/2017 16:01
Adviser guide to salary exchange TYE 2017
Scottish Widows
47786
a4 port
cmyk
210
1
Pensions - Corporate
297
04
17
07-Mar-2017
10
10
16:00:56
N
N
N
Salary Exchange
INTRODUCTION
THE PENSION ENVIRONMENT IS EVOLVING. GONE ARE THE DAYS WHERE A STANDARD
APPROACH TO SAVING FOR RETIREMENT WAS THE ONLY OPTION. NOWADAYS WE
CAN SEE EMPLOYER’S PENSION SCHEMES WITH DISCOUNTS, THEIR OWN SPECIALLY
SELECTED DEFAULT FUNDS AND SELF-INVESTMENT OPTIONS.
There are various options which can be tailored to suit
the needs of the employer, to make their scheme cost
effective and attractive. Salary exchange (also known
as salary sacrifice) is one of those options. This guide
explains how it works, who it’s suitable for and how
it can benefit both the employer and employee. With
automatic enrolment now well underway, salary exchange
is likely to become more popular as employers look to
use their National Insurance Contributions savings to
help offset the increased pensions costs associated with
Automatic Enrolment.
Insurance Contributions (NICs) on the exchanged amount.
WHAT IS SALARY EXCHANGE?
The employee decides how much they want to exchange
and their salary is reduced by this amount. The exchanged
amount can then be paid to the employee’s pension plan
as an employer contribution. The exchanged amount will
therefore be included in any employer contribution shown
in our illustrations and annual statements.
Some of the benefits could include:
• increased pension for employees
• increased take home pay for employees
• adding value to the benefits package
• reduced costs for employer.
HOW DOES SALARY EXCHANGE WORK?
Salary exchange is an arrangement where an employee
gives up the right to part of their future earnings or
bonus in exchange for a non-cash benefit.
As part of the salary is being ‘exchanged’ rather than
paid neither the employee or the employer pay National
1
E02223890_47786_0417.indd 1
07/03/2017 16:01
Salary Exchange
SETTING UP A SALARY EXCHANGE
ARRANGEMENT
WHERE CAN SALARY EXCHANGE BE USED?
In order for salary exchange to be considered, a pension
scheme which can accept employer contributions must
be in place.
The exchange is achieved by altering the employee’s
terms and conditions of employment. It can be set up at
any point but the salary exchange agreement must be in
place before the salary is actually exchanged to meet the
HM Revenue & Customs (HMRC) guidelines. HMRC also
state in their guidance that they require ‘full details of
the scheme and of the new contractual arrangements’.
Salary exchange can be used with:
• an occupational money purchase scheme
• a group personal pension (and personal pension)
• a group stakeholder pension (and individual
stakeholder pension)
The full set of guidelines can be found at
www.gov.uk/salary-sacrifice-and-the-effects-on-paye
• an executive pension plan.
CHANGE TO CONTRACT OF EMPLOYMENT
Note: Salary exchange is considered a matter
of employment law, not tax law.
To set up salary exchange, the employee’s contract of
employment must be changed and this should be formally
agreed between the employee and the employer, for
example in a letter. A copy of this agreement letter should
be kept with the employees original contract of employment.
It is essential that the agreement is in place before the
salary is exchanged, and well in advance of the first payment.
WHAT ABOUT SMART PENSION SCHEMES?
The basic principle of the employee giving up part of
their salary in exchange for a non-cash benefit doesn’t
change with a smart pensions scheme; but the sign up
method is different.
For Smart Pension schemes, HMRC is satisfied that as
long as the revised terms and conditions of employment
are communicated to employees in advance of the salary
exchange arrangement being introduced, then employees
who do not opt out are accepting the variation to their
employment contract. For contract based schemes, it
should be noted that there may be additional contract
and/or employment law considerations. Where employers
intend to implement a salary exchange arrangement
without obtaining the employees’ explicit consent,
we strongly recommend that legal advice is sought
before any change is made.
Rather than obtaining separate agreement from each
employee to go ahead with their exchange, smart pension
schemes instead rely on employees who do not wish to
participate to opt out of the proposed exchange. Employers
would communicate to their work force, advising them
that the proposed salary exchange will take effect from
a specified date (this date must be in the future).
Any employees who do not wish to take part must
actively opt-out. The employer must ensure that
employees are given plenty of time to make their
decision. Scottish Widows recommend a minimum
of 4-8 weeks notice.
It is up to the employer to specify the length of time
the arrangement will last for (this is usually a 12 month
period). The employer may wish to include the option to
change the arrangement if an employee were to experience
a ‘lifestyle change’. The employer should define the
‘lifestyle changes’ applicable to the arrangement.
Following the introduction of automatic enrolment,
HMRC have confirmed that it is permissible for a salary
exchange arrangement for a workplace pension scheme
to be changed on request, and now they don’t insist
on the exchange being for a set period or for lifestyle
changes to be specified.
The automatic enrolment legislation does not permit
employers to make salary exchange a condition of
enrolment into the scheme. However, it is possible to
amend employees’ contracts to make it a condition
of their employment that contributions are made via
salary exchange. There are other ways an automatically
enrolled scheme can use salary exchange. These
include:
• Enrol members into the scheme and then offer them
the opportunity to contribute via salary exchange.
• Enrol members into the scheme and offer them the
opportunity to contribute via salary exchange at the
same time.
2
E02223890_47786_0417.indd 2
07/03/2017 16:01
Salary Exchange
SETTING-UP THE ARRANGEMENT
The employer can set up the arrangement in a number of ways, however reinvesting the employer NIC savings will give
the employee the most benefit and may encourage scheme take-up. In this guide we’ll look at the 4 main options.
The scenarios below assume an employer provides a Group Personal Pension (GPP) arrangement. The employee earns £25,000
a year with both the employer and the employee currently paying a contribution of 5% of gross salary.
The examples show the different ways salary exchange works if the employee percentage is no longer paid by the employee
but is exchanged and paid direct by the employer.
Option 1 (employer and employee NIC reinvestment)
Employer costs stay the same, employee’s take home pay stays the same and the pension contribution increases. With this
option, the position remains cost neutral for both parties and all the employer’s and employee’s NIC savings are reinvested
into the pension scheme so the overall contributions are increased.
OPTION 1
Before Exchange
After Exchange
Benefit
Employer position – Total cost (salary, pension & NICs)
£28,573.37
£28,573.37
£0.00
Employee position – Take home pay
£19,279.68
£19,279.68
£0.00
Total gross pension contributions
£2,500
£2,923.53
£423.53
Option 2 (only employer NIC reinvestment)
Employer costs stay the same, the employee’s take home pay increases and the pension contribution increases. In this option,
only the employer’s NIC saving is reinvested, resulting in a higher pension contribution. The employee’s take home pay
increases as they are paying less NICs on a reduced salary.
OPTION 2
Before Exchange
After Exchange
Benefit
Employer position – Total cost (salary, pension & NICs)
£28,573.37
£28,573.37
£0.00
Employee position – Take home pay
£19,279.68
£19,429.68
£150.00
Total gross pension contributions
£2,500
£2,672.50
£172.50
Option 3 (no employer NIC reinvestment)
Employer’s costs reduce, the employee’s take home pay increases and pension contributions remain at same level. With
this option, none of the employer’s or employee’s NIC savings are reinvested in the pension scheme, but the employee pays
less NICS on a reduced salary, which increases their take home net pay.
OPTION 3
Before Exchange
After Exchange
Benefit
Employer position – Total cost (salary, pension & NICs)
£28,573.37
£28,400.87
£172.50
Employee position – Take home pay
£19,279.68
£19,429.68
£150.00
Total gross pension contributions
£2,500
£2,500
£0.00
3
E02223890_47786_0417.indd 3
07/03/2017 16:01
Salary Exchange
Option 4 (no employer NIC reinvestment)
Employer’s costs reduce, the employee’s take home pay stays the same and pension contributions increase. With this option,
the employee sacrifices a slightly higher amount to produce exactly the same take home pay. Because they’ve exchanged
slightly more, their pension contribution increases. In this example none of the employer’s NIC savings are reinvested.
OPTION 4
Before Exchange
After Exchange
Benefit
Employer position – Total cost (salary, pension & NICs)
£28,573.37
£28,370.43
£202.94
Employee position – Take home pay
£19,279.68
£19,279.68
£0.00
Total gross pension contributions
£2,500
£2,720.59
£220.59
The figures are based on tax and NI for 2017/18 tax year and a single person’s allowance of £11,500. The value of the
tax benefits of a pension plan depend on an individual’s circumstances. These circumstances and tax rules may change
in the future.
Our salary exchange tool can be requested through your Scottish Widows Account Manager, the tool will allow you
to calculate ‘real’ examples for individuals and group schemes.
OPTIONS AT A GLANCE
Options
Employer
costs
1
2
3
4
no change
Employee take
home pay
Pension
Contribution
no change
increase
Summary
This is cost neutral.
Employer – NIC saving is reinvested
Employee – sacrifices slightly higher amount
to keep their take home pay at the same level
so pension contributions are increased.
Employer – NIC saving is reinvested
Employee – does not have to pay NIC on the
amount sacrificed, so this increases their take
home pay.
no change
increase
increase
Employer – no reinvestment of NIC savings
Employee – as salary is reduced, the amount
of NIC paid is also lower, so this increases
their take home pay.
decrease
decrease
increase
no change
no change
increase
Employer – no reinvestment of NIC savings
Employee – sacrifices a slightly higher
amount so that they can get the same take
home pay. The higher sacrifice means they get
an increased pension contribution.
WHICH OPTION IS BEST?
There is no right or wrong answer. It’s really up to the employer to choose which option they want to go for and this will
depend on what their objective is, i.e. are they looking to reduce their costs or give employees additional benefits?
4
E02223890_47786_0417.indd 4
07/03/2017 16:01
Salary Exchange
THE BENEFITS
A valuable benefits package can also help the employer
to attract and retain quality staff, potentially giving
employers an edge over their competitors.
Employers will pay less NICs
The employees will be receiving a lower gross salary, this
means the amount paid in NICs by the employer will also
reduce. A quick way to estimate the NIC saving is to add
up the total of employee contributions and apply the
employer NIC payment rate of 13.8%.
THINGS TO CONSIDER
Salary exchange may not be suitable for everyone and
it’s important that the employer and employees are fully
aware that it is a legally binding contract they are entering
into. There are some other things that employers and
employees should think about regarding the impact
reduction in salary will have.
For example:
Average employee salary
Average employee contribution rate
Annual employee contribution
£20,000
Employer NIC rate
Annual employer NIC saving
• Other benefits which are linked to their salary, for
example, benefits on death, redundancy payments
and over-time rates may be impacted.
= £1,000
Active members
Total
Employees
x 5%
x 50
• Statutory benefits linked to the lower salary may also
be impacted. These include:
= £50,000
x 13.8%
– State pension
= £6,900
– Statutory maternity, paternity and sick pay.
– Working or child tax credit.
Initially, paying by salary exchange rather than making
payments directly may be off-putting to employees, as
they will be receiving a lower gross salary. However, the
individual will benefit from exchanging part of their salary
towards providing for their retirement and at the same
time, benefit from reduced NICs. This saving can be used
to further enhance their pension contribution or alternatively
increase their take home pay.
More information can be found at
www.gov.uk/salary-sacrifice-and-the-effects-on-paye
• Mortgage lenders usually base the amount which can
be borrowed on the salary after the exchange; this will
reduce the amount that the employee can borrow.
• Earnings must not fall below the National Minimum
wage as a result of salary exchange.
Of course if the employer reinvests some of their NIC
saving, the employees will also benefit from this.
• Rules for an Occupational Pension Scheme (OPS)
state that if an employee dies while in pensionable
service or if they decide to leave the scheme with
less than two year’s pensionable service, their
contributions would be returned. This would not be
the case with salary exchange, as the contributions
would be considered employer contributions and
therefore, contributions would not be returned.
Adding value to the benefits package
Introducing salary exchange can improve the employee’s
perception of their benefits package, particularly if the
employer agrees to reinvest their NIC savings to further
increase the pension contributions. This may encourage
employees to join the scheme.
5
E02223890_47786_0417.indd 5
07/03/2017 16:01
Salary Exchange
Employers
To help we’ve produced literature for employers and
employees on how salary exchange works, how it can
impact them and how it can benefit them.
• What they plan to do with the NIC saving – they
don’t have to reinvest it but it may be difficult to
promote salary exchange to employees if they are
not going to benefit from this saving.
Employer
Our employer guide details all four options and how they
work as well as covering topics such as how to set the
scheme up, the costs of setting it up and the benefits.
• Retaining a ‘notional salary’ (this is the salary before
the exchange) or ‘reference salary’ for employees.
This would mean that their pre-exchange salary
could be used for things like mortgage references,
over-time rates and pay increases. HMRC provide
more information on this at:
http://www.hmrc.gov.uk/manuals/eimanual/
EIM42771.htm
Employee
Our salary exchange flyer with the member joining
guide details the benefits of contributing to the
scheme, including case study examples. To accompany
this we have also produced two employee ‘quick’
guides highlighting the key benefits and potential
disadvantages of salary exchange. One covers
employer NIC reinvestment and the other no employer
NIC reinvestment.
• The potential costs should an employee be absent
from work for a long period of time, for example
long-term sick. The new contract of employment
moves the responsibility for making the pension
payments from the employee to the employer so
the employer would have to continue making the
payments for the remaining exchange period if the
employee is not receiving occupational sick pay.
This would also apply to maternity leave.
CAN SALARY EXCHANGE BE ALTERED?
For workplace pensions, HMRC have confirmed that
salary exchange can be altered on request, with no
requirement for a minimum period or for a ‘lifestyle
change’ to have taken place.
• If the employer is considering a Smart Pension scheme
we strongly recommend that they seek legal advice
before any change is made.
SALARY EXCHANGE CALCULATOR
COSTS
We’ve developed a salary exchange calculator which
you can request from your Scottish Widows Account
Manager. This calculator demonstrates how salary
exchange works.
The costs associated with salary exchange are mainly
related to the extra administration and employer’s
communications.
There are 3 ways the costs could be covered. The employer
could:
It provides:
• bear the full cost of the set up
• individual calculations
• bulk calculations
• use some of their NIC saving to cover part of the costs
• ability to save outputs
• use all of their NIC saving to cover the costs.
• links to our salary exchange website and literature
• information on how salary exchange works
COMMUNICATION
• sample letters.
The success of a salary exchange scheme will be measured
by how many employees sign up. There would be nothing
more frustrating than an employer taking the time to set
up a scheme and bearing the costs of this if take up is low.
Clear communication is essential if a salary exchange
arrangement is to be successful.
6
E02223890_47786_0417.indd 6
07/03/2017 16:01
Salary Exchange
PAYROLL
NEXT STEPS...
Implementing a salary exchange arrangement will have
an administrative impact on the employer.
If you would like to find out more about salary exchange
or discuss developing a communication strategy with
any of your clients, we can help. For more information
please get in touch with your Scottish Widows Account
Manager or access our website at
www.scottishwidows.co.uk/salaryexchange
The employer will need to think about how their systems
and processes will be affected. If new procedures are
necessary, how will this be communicated to the employees?
We’ve provided an example of what a payslip could look
like on page 8. Basically, the employer should ensure the
exchange amount doesn’t appear under the ‘deductions’
section. The entry can be described in any way, so long
as it is clear enough for the employee to recognise it is
the exchanged amount.
WHERE CAN I FIND OUT MORE?
HMRC has extensive guidance on its website about
salary exchange. You can find this information at:
www.gov.uk/salary-sacrifice-and-the-effects-on-paye
Some payroll software can only hold one salary for each
employee. As long as the amended terms and conditions
of employment have been clearly communicated to the
employee, the salary exchange will be valid.
7
E02223890_47786_0417.indd 7
07/03/2017 16:01
Salary Exchange
SAMPLE PAYSLIP
Company name
Employee name
Joe Bloggs
Pay Period
12
NI number
AA 12 34 56 C
Tax code
512L
Employee payroll number
00000001
Employer tax office reference
XXX / X
Contact telephone number
01XXX XXX XXX
Payments
Amount
Basic Pay
£
Salary exchange
-£
Overtime
£
Bonus
£
Total
£
Deductions
Amount
Tax
£
National Insurance
£
Net Pay
Amount
£
Bank account details: XXXXXXXXXXXXXXXXXXXXXXXXX
8
E02223890_47786_0417.indd 8
07/03/2017 16:01
Scottish Widows Limited. Registered in England and Wales No. 3196171. Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN.
Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 181655.
47786 04/17
E02223890_47786_0417.indd 9
07/03/2017 16:01