Salary Exchange and Child Benefit
We have mentioned in previous blogs about the fact that National Insurance contributions are merely another form of taxation on both you as an employee and also your employer.
There are a number of strategies you can consider, although in recent years the Government have reviewed many of these under anti-avoidance measures. One that has been left untouched is salary exchange (sometimes referred to as Salary Sacrifice).
Salary exchange has been commonly used in the past and in fact it is referred to on the HMRC website. It is a tried and tested way to reduce your liability (and your employers) to national insurance contributions (NICs). In essence you give up your right to part of your salary in exchange for receiving something else from your employer. Most commonly this has been used in exchange for a pension contribution from your employer, which is equivalent to the salary being exchanged plus, if the employer agrees, the NIC savings. However with the imminent changes to child benefit from 7 January 2013, you may be able to use salary exchange to your advantage, to get a very attractive pension contribution plus ensuring you keep your child benefit entitlement.
Salary exchange is set up by the employer issuing a letter detailing the reduction in salary from a given date and detailing the increase in pension contributions from a given date. It is important to note that this must be done before any entitlement to the salary is earned. Both employer and employee will sign to agree the changes.
In the last budget the Chancellor confirmed there will be a tax charge for people with income over £50,000 if they or their partner are in receipt of child benefit. The new rule comes into place 7 January 2013.
For anyone whose income is between £50,000 and £60,000, the tax charge will be 1% of the amount of child benefit for every £100 of income in excess of £50,000. For those earning over £60,000 they will effectively have lost all their child benefit.
However for the current tax year 12/13, the child benefit tax charge will only apply to child benefit paid from 7 January 2013 to 5 April 2013 although the income for the full tax year will be used.
Lets assume, Paul, is married with two children, and receives child benefit of £1,752pa. If Paul’s income is £55,000, then the tax charge will be £876, which is £17.52 for every £100 of income above £50,000.
The income for the purposes of the calculation is an individual’s ‘adjusted net income’. It is this measurement, which allows us to use salary exchange to save on the tax charge.
If Paul exchanges £5,000 of his salary his total income is reduced to £50,000. The monthly equivalent is £416.67. We have set out below how this would work.
Income Tax (at 40%) £166.67
National insurance (at 2%) £8.33
Net Pay £241.67
This would produce the following savings for the employer:
Reduction in salary
National insurance saving (at 13.8%)
Total employer saving
The employer would then pay the £474.17 into the employees pension. This reduction in salary would also save £73 per month in child benefit tax charge (£876/12). By exchanging £416.67, Paul has saved 40% income tax, 2% NICs and 13.8% employer NICs and a child benefit tax charge. The total saving is £166.67 + £8.33 + £57.50 + £73 which gives a total saving of £305.50. This is an effective savings rate of 73.3%.
For further information on how we could help you make similar savings please give us a call.
Paul Dixon FPFS
Chartered Financial Planner