Salary Exchange: It’s a no-brainer, so why not?
Finding an employer with a healthy attitude towards their employees shouldn’t be difficult. There’s a growing archive of studies showing that a valued workforce is more productive and loyal to inform those who are not philanthropic in nature that their staff ought to be a priority. And it is true at this time of low wage inflation that finding other means, beyond the traditional pay rise, to express satisfaction in an employee requires creativity. However, there is a well- established principle that allows employers to do just that.
Salary Exchange
Salary exchange is just that. Where salary is exchanged for an alternative benefit which is not deemed a benefit in kind and so, critically, its value is not subject to income tax or national insurance contributions. Thanks in no small part to the cycling successes of Sir Chris, Sir Brad and Queen Vic, the cycle to work scheme has been a roaring success. This is, in fact an example of salary exchange where the purchase of a bike, within permitted parameters, can be made by deduction from one’s salary prior to the calculation of one’s tax and national insurance liability. As a consequence the employee can spend up to a thousand pounds on a bike, yet only experience a reduction in their net or ‘take home’ pay of, say, five-hundred pounds (depending upon their actual income). Perhaps it’s time to ask your boss if you can trade in that bone-shaker?
The reason that a bike purchase of this kind can qualify for tax relief is because its intended purpose must be for commuting to work, and so reduce the gridlock on our highways and byways at peak times whilst also offering Britain’s workers some health benefits. When a government wants to encourage a particular behaviour or habit, it often nudges HM Treasury to give us all a little incentive such as this.
Another example is childcare vouchers. This initiative mirrors the cycle to work scheme with salary being exchanged for childcare vouchers to effectively reduce the impact that putting children in nursery has on a young family’s income. The government wants us to be working, so it offers a tax break to those of us with young children. This too has a cap of a few hundred pounds per month, lest we feel inclined to have too many children, I assume. However, there is a benefit where the ceiling on the benefit is really very generous.
Pensions
Finally, the penny has dropped; workers of all ages are beginning to appreciate the extent of the gap in their collective pension planning. But stagnating pay and high inflationary rises in the cost of living make saving for anyone difficult, not least those of us living in a nation with a penchant for credit and the ‘buy now, pay later’ culture. But salary exchange can help ease this challenge, whilst simultaneously letting those on the payroll know that they are valued.
Just like the examples above, pension contributions enjoy tax relief, however they do not benefit from relief from national insurance contributions. That is to say, unless they are deemed to be employer contributions. So how does salary exchange help? If an employee agrees to exchange a portion of their salary in favour of an equivalent contribution to their pension, the employees pay packet swells with the national insurance contribution saving made on the sacrificed income. In short, salary exchange can mean that the impact of making a pension contribution is reduced for the employee.
But the benefits don’t stop there. For an employee motivated to enhance their pension contribution, but who doesn’t need the relevant saving in their bank account, their pension contribution can be increased by the amount saved from the reduction in national insurance contributions. Good, eh? By agreeing to salary exchange with their employer, an employee can take home the same pay, but have a larger pension contribution.
And for the truly philanthropic employer? Well, employers pay national insurance contributions on their salary bill too. However they don’t on their employer pension contribution bill. So if an employee wants to benefit from salary exchange, their employer also makes a saving. The temptation is to pocket this and save the business a few ‘bob’. But what if the employer recognised that they could use this saving to further enhance their employee’s pension contribution at effectively no cost? Surely any method of enhancing a treasured employee’s remuneration at zero cost is worth considering?
Education
The question is surely: Why don’t employers do this? In eleven years of Financial Planning, my efforts to encourage the implementation of salary exchange have been, to say the least, frustrating. I believe that this is largely due to the fact that, though the principle is simple, engagement requires trust and understanding. More often than not, advisers are instructed by either an employee or an employer to act on their behalf, and for salary exchange to be embraced it requires a three-way relationship, the development of which is not always afforded the necessary time to build sufficient trust and understanding. But when the dynamic is right, and both staff and employer are engaged, advising on the benefits of salary exchange can be one of the most rewarding components of my working life. It truly is a win, win arrangement.
What should Advisers be doing?
If advisers are building strong working relationships first and foremost, the rest is relatively easy. To quote Kevin Costner in the deliciously hokey ‘Field of Dreams’: If you build it, they will come. All too often there is an urgency in this industry which is not conducive to efficiency. Implementing a compliant auto-enrolment pension scheme for a local firm, for example, might be the goal. So why not spend the extra time to ensure that it’s the best scheme it can be by helping all involved understand how salary exchange can help employees achieve their retirement objectives? It sounds obvious, but a decade of experience tells me that salary exchange is a topic of conversation all too often side-stepped by advisers.
The views expressed are those of Thorntons Wealth. The contents of the article are solely for information purposes and are not intended as advice.