What is a pension salary exchange? How can you implement one? Pension schemes might be the last thing you want to contemplate, but Nick Bustin from Haysmacintyre says it's time to reconsider and take action.
The recent Spring Budget saw several incentives to encourage people to stay on at work a bit longer, or return to work, which can make the use of a pension salary exchange an attractive proposition.
What is a pension salary exchange?
A pension salary exchange is a legitimate method of providing pension arrangements, and at the same time generating savings for both the employer and the employee.
The savings are realised as the employee agrees to reduce their salary in exchange for their employer paying the equivalent amount in pension contributions on their behalf.
Step 1 – Creating your action plan
Consideration will need to be given to the viability in setting up a pension salary exchange, with the following being key points to bear in mind:
- Who will be responsible for overseeing the implementation of the pension salary exchange?
- How many employees are currently participating in pension schemes?
- Who is eligible to participate in the scheme?
- What are the potential National Insurance savings which can be generated?
- How best do you communicate it with your employees?
- How do you ensure employees are aware of the benefits and downsides of participating in a pension salary exchange?
It is our recommendation that somebody, either the HR or finance team, manages the implementation of the pension salary exchange, having clear oversight throughout the process.
Step 2 – Staff participation
The more employees who take part in the pension salary exchange, the greater the number who will benefit from the savings which can be obtained – as will the employer.
A common question asked is whether the employer should invite employees to ‘opt-in’ to the scheme; or, alternatively, to transfer all ‘eligible’ employees into the scheme, giving them the opportunity to ‘op-out’ should they not wish to participate.
Both alternatives are viable and acceptable to HM Revenue & Customs. However, the ‘opt-out’ method does lend itself to a higher level of participation and potentially a lower level of administration post-implementation.
When you are considering whether there are any employees who should not take part, it will include those who are at, or close to, the National Minimum/Living Wage (NMW) hourly rates. Furthermore, it is important to ensure that employees who are earning a reasonable salary do not sacrifice too much of their income, which could take them below the NMW hourly rates.
Step 3 – Notifying employees
The employer should notify all employees regarding the intention to introduce a salary pension exchange. The most common approach is to write to every employee, advising them about the employer’s intention to provide a pension salary sacrifice arrangement.
You can provide:
- Details regarding the pension scheme you are proposing to use
- Why you are proposing the use of a pension salary exchange
- The advantages and disadvantages for entering the scheme
- Illustrations to demonstrate the pre/post pension salary exchange position
It is also our experience that not all staff read the emails which are sent to them! To help with the communication process we recommend the use of:
- An all-employee briefing, for example on Teams or Zoom
- Department meetings
- An article in a staff newsletter
Furthermore, the use of an all-employee briefing helps to provide everyone with a consistent message and the opportunity for employees to ask questions. It also helps to create a ‘model’ approach for any subsequent department meetings.
Step 4 – Discuss with other key participants
Whilst the employer and its employees will benefit from the arrangement, it is also important to consult with your pension scheme and payroll providers that you are proposing to set up the pension salary exchange arrangement.
They will be familiar with how the arrangement works and will be able to help you with some of the logistics – for example, changes to:
- The wording on your employee payslips
- Reports to be shared with the payroll provider
- Ensuring the pension provider treats the payments it receives as employer only contributions
However, it is wise to give them sufficient notice about the changes you are going to introduce to the pension scheme.
You will also need to prepare the key documents to send to employees, including letters and/or emails which will help to vary the terms and conditions of employment, especially the amount an employee wishes to exchange in favour of employer funded pension contributions.
Step 5 - What are the key messages?
The following provides a summary of the topics which need to be conveyed to employees:
- Under a pension salary exchange, the employee agrees to a reduction of their salary by an amount equal to their pension contributions
- The employer agrees to pay the employee pension contributions, which are added to their pension contributions as total employer only contributions
- As the employee’s gross pay is reduced, both the employer and the employee pay less National Insurance
It is not uncommon for the employer to share all or part of their National Insurance savings with the employees in the form of additional pension contributions.
For the employee, they will receive further benefits in addition to the National Insurance savings which will include:
- Immediate tax relief, based on their marginal rate of tax owing to the reduction in the level of their taxable earnings
- This is particularly helpful for higher rate taxpayers who, where they participated in a defined contribution pension scheme, needed to claim higher rate tax relief via the Self-Assessment Tax Return
- Student loan repayments are calculated based on the lower post salary exchange earnings
However, as an employer it provides an opportunity to remind employees of the need to better prepare for their retirement.
Step 6 – Long-term participation
Employers will want to ensure the long-term participation into the pension salary exchange arrangement, so the employee needs to be made aware that they will have to participate for a minimum period of 12 months.
However, there will need to be an annual renewal process enabling employees to either ‘opt-out’ of the arrangement or vary the level of earnings they wish to exchange in favour of employer-funded pension contributions. Consideration will also need to be put in place to consider any ‘lifestyle’ changes, which will enable the employee to stop participating in the arrangement on a temporary basis (typically a minimum period of 12 months).
Common examples of lifestyle changes include:
- Marriage or Civil partnership
- Birth of a child or key dates in the adoption of a child
- Changes of formal custody arrangements
- Redundancy or loss of job or change in work patterns of a partner or spouse
- A significant change in working hours
- Divorce, legal separation, or dissolution of a civil partnership
The use of prescriptive lifestyle changes is to prevent employees from dipping in and out of the arrangement.
There are downsides which employees need to be made aware about, which include the following:
- The pension salary exchange must not bring an employee’s earnings below the National Living/Minimum Wage limits
- Lower life cover is often calculated as a multiple of salary and the arrangement will make the salary figure lower
- Currently not beneficial to employees’ over pensionable age
- Potential impact on state related benefits
- Salary will vary the employee’s terms and conditions of employment
Many employers will share some, if not all their National Insurance savings with the employees in the form of additional pension contributions. Additionally, some employers are taking the opportunity to use some of the savings to:
- Help provide a staff award scheme
- Fund other benefits
- Apply them against other staffing costs
The consensus is that the benefits of entering a pension salary exchange are seen as out-weighing downsides, with employees seeing a small increase in their net income. It will help employers to make their staff budget stretch that bit further.
Step 7 – Post implementation
As with many projects a lot of work is conducted leading up to its implementation. However, it is important for a successful implementation of the pension salary exchange to consider the following:
- Obtain staff feedback, especially around how the employer explained the arrangement
- Ensure all new employees joining the employer receive the same information
- Continue to promote the arrangement during the year, especially when employees are asked to review their participation and increase the level of salary, they wish to forgo in favour of additional pension contributions
Where the employer has retained some of its National Insurance savings to help fund a staff award scheme, do not forget to put a scheme in place. It can be a simple arrangement – for example, providing gift vouchers where an employee has done a good job.
The employer can meet the Income Tax and National Insurance liabilities due on the gift via a PAYE settlement agreement.
Case study
A client had closed participation into a long-standing pension scheme and wanted to establish a pension salary exchange arrangement for all its employees.
The client's key objectives were discussed, following which an action plan was created. Haysmacintyre provided the staff presentation, together with a frequently asked questions document, to help answer questions which employees may ask during the implementation period.
We helped the client with the key documents needed to ensure an effective pension salary exchange was implemented, together with illustrations to help the employees understand the implications of what entering the arrangement meant to them.
We provided support to the HR team who were responsible for the arrangement, and we continue to be available to them post-implementation.
The introduction of the pension salary exchange has helped the client to engage with all its employees regarding their pension savings. It has not only provided greater awareness for the employees about the importance of looking to their future retirement, but they felt valued as the client shared part of their National Insurance savings in the form of enhanced pension contributions.