Benefits of salary exchange

Prior to last year’s Autumn Budget, tax increases were predicted. Talk and speculation regarding “black holes” in government spending and a multi-billion-pound deficit in public finances gave us a taste of things to come. The Chancellor mentioned that “difficult decisions” had to be made, and one of the most impactful changes to come from the budget is the forthcoming increase in employer National Insurance contributions (NICs).

From the 6^th of April 2025, the rate of employer NICs will increase from 13.8% to 15%. In addition to this, the threshold at which employers start paying NICs will be reduced from £9,100 to £5,000 per employee. It is estimated that this will raise UK government tax revenue by nearly £25 billion a year.

To help small businesses offset the increased employer NIC costs, an increase to the Employment Allowance was also announced in the budget.

The Employment Allowance is designed to support smaller businesses by reducing their total employer’s NICs. In tax year 24/25 the allowance is £5,000, and from the 6^th of April 2025 it will be increased to £10,000. The eligibility criteria for the Employment Allowance will also be relaxed, and full details of the forthcoming changes are outlined on the gov.uk website. It’s worth checking if you’re eligible if you haven’t already done so!

The increase in the Employment Allowance will boost the number of employers that will benefit from a reduction in their employer NICs in the next tax year. With that said, a much larger proportion of employers will see a sharp increase in their employer’s NICs. The Institute for Fiscal Studies predict that employers could pay an additional £770 a year in employer NICs for a minimum wage worker, or an extra £900 for an employee earning £33,000.

Whilst these changes will have no direct impact on employees, some employers may pass on the increased employer’s NIC costs to employees by limiting pay increases and recruitment. For some, redundancies may be a possibility.

But there is an arrangement which can reduce NICs for both employers and employees. This arrangement has grown significantly in popularity over the last few years due to its tax benefits, and it’s known as pension salary exchange (also known as salary sacrifice).

Pension salary exchange is an agreement between an employer and their employee. Under this arrangement, the employee agrees to a reduction in their salary that is equal to the amount that they contribute to their pension. In return, the employer will pay the employee’s pension contribution instead.

To put this into practice:

• An employee earning £28,000 a year gross is contributing 5% of this into their pension
• This equates to a pension contribution of £1,400 each year
• Their employer is paying a 3% pension contribution of £840
• Without salary exchange in place, both employer and employee NICs are based on this employee’s gross salary of £28,000
• Under a salary exchange arrangement however, £1,400 is deducted from this employee’s salary, and the employer instead makes an additional pension contribution of £1,400
• So the employer’s total pension contribution will be £2,240 (£840 + £1,400), and the employee’s pension contribution is reduced to £0
• This means that the employee’s gross salary has effectively been reduced by £1,400 to £26,600
• Consequently, employer and employee NICs will be based on £26,600 rather than £28,000
• This results in a National Insurance saving for both the employer and the employee. The employee’s take home pay is not reduced as a result of this

It is important to keep in mind that because salary exchange reduces an employee’s gross salary, it won’t be an option for employees whose salaries will fall below minimum wage if they partake.

And whilst the above example relates to pension salary sacrifice, the same principle can be applied to other salary exchange schemes (i.e. Cycle to Work schemes & car leasing arrangements).

I’m here to help! My name is Michael Boateng, I’m the Workplace Benefits Consultant at Albert Goodman. I’ll be happy to answer any questions you have regarding salary exchange, and how the associated tax savings could benefit your business.