Salary exchange, or salary sacrifice, is a contractual arrangement where employees swap earnings for a tax-free benefit. Other tax-free company benefits can include childcare support/vouchers, company car and cycle schemes, or annual health check-ups. The most common use sees workers reduce their salary in exchange for increased pension contributions. A 1.25% National Insurance rate rise, which came into force on 6 April, means it may be even more attractive for employees (and companies) to exchange some of their salary for pension contributions.
Save on National Insurance via salary exchange
Pension contributions attract income tax relief up to the £40,000 annual allowance (subject to some limits/restrictions). Tax relief can be automatic (under the ‘net pay’ method), or the taxpayer may need to claim it under the ‘relief at source’ system. NICs are due on the gross income under both these methods, but they don’t apply if you sacrifice pay through salary exchange.
For every £10,000 pension contribution through salary exchange, employees can save between £325 (see table below) and £1,325 in NICs. This is based on rates of 13.25% on earnings between £9,880 (£12,570 from July 2022) and £50,270, and 3.25% for those earning above £50,270, inclusive of the new 1.25% levy. Employers also save on NICs – employer contributions are now 15.05% on earnings above £8,840 as a result of the April tax changes – via salary exchange. Some companies pay part or all of their savings into their employees’ pension pots.
Potential drawbacks
Reducing salary could impact other salary-related benefits, such as bonuses, insurance cover, or maternity/paternity cover (unless your employer adjusts benefits to pre-exchange levels). It might also impact your mortgage or loan borrowing capacity. Check the details of the scheme if your employer operates salary exchange. There is usually an annual window that allows you to opt in or make benefit changes.
Are you unsure how pension contributions fit within your overall tax planning strategy? Call 03300 564 446 to speak to a Lumin expert, or book a free introductory meeting by visiting luminwealth.co.uk/contact.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
