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Tech centre - Financial planning bulletin

Salary exchange for high earners

Jul 11, 2018, 15:28 PM

Summary


It is still possible for an employee to exchange part of their salary and/or bonus in return for an employer pension contribution on their behalf. This article will look at the benefits of salary exchange for those earning in excess of £100,000.

Facts and analysis


  • When an employee exchanges part of his salary/bonus in return for an employer pension contribution the end result will normally be that a larger pension contribution is made by the employer than the employee could have made on his own account. This will particularly be the case where his employer is prepared to increase the pension contribution by all or part of their NI contribution saving resulting from the exchange.

  • The following table highlights the difference between the employee making a personal contribution and the employer making a contribution using exchanged salary. It is assumed the employer is prepared to increase the contribution to reflect the 13.8% NI contribution saving. It is based on £10,000 gross salary.

 

Personal Higher Rate Taxpayer (£)

Personal Additional Rate Taxpayer (£)

Employer/Salary Exchange (£)

Gross Salary

10,000

10,000

nil

Income tax

(4,000)

(4,500)

n/a

NI contributions 2%

(200)

(200)

n/a

Net pay equal net contribution

(5,800)

(5,300)

n/a

20% tax relief at source

1,450

1,325

n/a

Gross pension contribution

7,250

6,625

11,380

Higher/Additional rate reclaim*

1,450

1,656.25

n/a

*The tax reclaim could be used to make a further pension contribution, upon which further relief would be obtained. However, it should be noted there will be some delay between making the personal pension contribution and receiving higher rate relief.

As can be seen, by using salary exchange there is substantial increase in the available pension contribution at no additional cost to the employer.

The phasing out of the personal allowance for individuals with gross income of over £100,000 means that salary exchange can hold further attraction for those with income above £100,000 before salary exchange and below £123,700 following exchange, in 2018/19.

Example 

George has income of £110,000 in 2018/19. His personal allowance will be lost at the rate of £1 personal allowance for each £2 of gross income George has above £100,000. This example illustrates the pension contribution that could be made directly by George if this were based on the top £10,000 of his gross income, and the comparable contribution that could be paid by his employer if George exchanged £10,000 of salary.

 

 

Personal (£)

Employer/Salary Exchange (£)

Gross salary above £100,000

10,000

nil

Income tax on salary (40%)

(4,000)

n/a

Lost personal allowance: £1,833@40%*

(733)

n/a

NI contributions

(200)

n/a

Net pay equal net contribution

5,067

n/a

20% tax relief at source

1,267

n/a

Gross contribution

6,334

11,380

HRT reclaim

1,267

n/a

*The grossed up personal contribution of £6,334 reduces gross income over £100,000 from £10,000 to £3,666, hence a loss of £1,833 of personal allowance.

The employer contribution of £11,380 assumes that the employer will gross up the £10,000 exchanged salary to allow for its 13.8% NI saving. This case also illustrates how the exchange of £10,000 will result in George retaining all of his personal allowance as his post exchange income will not exceed £100,000.  Taking all of this into account, the use of salary exchange can result in a substantial increase in the available pension contribution.

When implementing salary exchange consideration must be given to the following:

  • Salary exchange may potentially impact on the employee’s other benefits. For example, where the employee is a member of an occupational scheme or a group life assurance scheme with salary related benefits, a salary reduction could result in those benefits being reduced unless the employer is prepared for them to continue to be based on his pre-exchange salary.

  • For a salary exchange to be effective it must be made before the remuneration being given up is treated as received for employment income tax purposes.

  • For an employee this will normally be the earlier of:

- the date the payment is made, and

- the time the individual becomes entitled to the payment.

  • For individuals who may be caught by the tapered annual allowance, it should be noted that the definition of threshold income (£110,000) includes the amount of any employment income given up for pension provision as a result of a salary exchange made on or after 9 July 2015

Next steps


  • For the vast majority of employees, salary exchange will continue to be a very attractive means of “paying” their pension contributions. Seek out those employees who could benefit from salary exchange.

  • An increasing number of employers are offering such salary exchange arrangements, passing on part or all of their NI saving, to enable employees to maximise their pension savings. Seek out those employers who do not presently offer salary exchange arrangements, and explain the attractions of offering salary exchange as part of their employee benefit package.

Learning outcomes and reflective questions for CII accredited CPD


Reading this article can count towards structured CPD under the CII CPD Scheme if you consider the Learning Objectives below to be directly relevant to your own personal professional development plan. The Reflective Questions don’t require answering, they are aimed to help you reflect on the issues raised in the article for your reflective statement on your CPD Certificate.

Learning objectives:

  • To review the income tax and national insurance savings for a high earner using salary exchange for a pension contribution
  • To calculate the additional pension contribution that can be achieved using salary exchange

Reflective questions:

  • Can I calculate the tax saving for a client using salary exchange rather than an employee contribution?
  • Is there any downside for my client if they use salary exchange?

Important information


This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2018.  It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice.  Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients.  You should always seek appropriate legal or other professional advice.

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