Business owners naturally want to reward good team members.
Whether someone has taken on more responsibility, performed consistently well or become a key part of the business a pay rise can feel like the obvious answer.
However, once an employee starts moving towards higher rate tax a salary increase may not always deliver the value expected.
That does not mean employees shouldn’t receive pay rises – far from it. But it does mean there may be more beneficial ways to structure an overall reward package, especially where a wage increase could push someone into higher rate tax or affect other areas of their personal finances.
The higher rate tax issue
For many employees, higher rate tax starts when income exceeds £50,270.
This means part of a pay rise may be taxed at 40%, before also considering employee National Insurance, student loan repayments where relevant and other income-related issues.
There can also be other knock-on effects. For example, employees with children may need to consider the High Income Child Benefit Charge once adjusted net income exceeds £60,000. In some cases, this can mean the real benefit of a pay rise is much lower than expected.
A simple example would be an employee receiving a £5,000 salary increase, but after tax, National Insurance and other deductions, the actual increase in take-home pay may feel disappointing.
That’s why it can be worth asking a slightly different question:
Is a salary increase the best way to reward this person, or could a wider benefits package create better value?
Pension contributions
Pension contributions are often the best place to start.
Rather than increasing salary, an employer may consider making additional pension contributions. This can be attractive because employer pension contributions are normally tax deductible for the business, do not usually create an employee National Insurance cost and can help the employee build long-term financial security.
This can be particularly useful where an employee is close to a tax threshold.
In some cases, pension contributions may help reduce adjusted net income, which can be relevant for higher rate tax planning, Child Benefit and the personal allowance taper for higher earners.
Salary sacrifice pension arrangements can also be worth considering. Under this type of arrangement, an employee gives up part of their salary in exchange for increased employer pension contributions. This can create National Insurance savings for both the employee and employer, although the arrangement needs to be properly documented and implemented.
It’s important to remember that pension planning should always be considered carefully. Employees need to understand the impact on take-home pay, mortgage applications, statutory payments, and their wider financial position.
Mobile phones and business technology
Some benefits are simple but still valuable. For example, an employer can provide one mobile phone to an employee without creating a taxable benefit provided the arrangement is structured correctly.
This can be more tax-efficient than giving the employee extra salary to pay for their own phone contract personally.
The same thinking can apply to certain business equipment, such as laptops, tablets, software, or other technology needed for the role. The key point is that the equipment should be provided for business purposes and the tax treatment should be checked before making assumptions.
This is an area where mistakes can easily happen. Reimbursing an employee for personal costs is not always treated the same as the employer providing the item directly.
Electric cars and salary sacrifice
Electric vehicles remain a popular employee benefit because the Benefit-in-Kind rates are currently much lower than for many petrol or diesel cars. For the right employee, an electric company car or electric car salary sacrifice scheme can be a very attractive part of a reward package.
This can be especially relevant where an employee is already considering changing their car, has a suitable commute or values the convenience of the employer arranging the vehicle.
From the employer’s perspective, an electric vehicle scheme can also support recruitment, retention and environmental objectives.
But remember this isn’t an area to enter into lightly. The business has a lot to consider – for example affordability, lease commitments, insurance, charging arrangements, mileage, payroll reporting and the impact on the employee’s salary.
Extra annual leave and flexible working
Not all valuable benefits need to be tax-led: for many employees, extra holiday, flexible hours, hybrid working or improved work-life balance can be just as valuable as a pay increase.
This is particularly true where an employee is already earning at a level where additional salary is being taxed more heavily.
For example, a business could consider:
- Additional annual leave
- Flexible start and finish times
- Hybrid working arrangements
- A compressed working week
- Paid study time
- Wellbeing days
These benefits can help retain good people and support productivity, without simply increasing gross pay.
Trivial benefits and staff perks
Small benefits can also play a part in making employees feel valued.
The trivial benefits rules allow employers to provide certain small benefits tax-free, provided strict conditions are met. Broadly, the benefit must cost £50 or less, must not be cash or a cash voucher, must not be a reward for work or performance, and must not be included in the employee’s contract.
This could include things like a small gift for a birthday, a seasonal gift, or a gesture to recognise a personal occasion.
However, trivial benefits should not be confused with bonuses or performance rewards. If a gift is linked to performance, targets, or duties, it’s unlikely to qualify.
Directors of close companies also need to be careful, as there are annual limits.
Staff events and team benefits
Annual staff events can also be valuable where they are planned correctly.
Many businesses use events such as Christmas parties, summer socials or team meals to reward staff and build culture.
There are tax exemptions available for qualifying annual events, but the rules need to be followed carefully. The event must be open to employees and the cost per head must stay within the relevant limit.
Again – this is not necessarily a replacement for salary but it can form part of a wider approach to rewarding and retaining staff.
Private medical insurance
Private medical insurance is a taxable benefit for the employee.
In some cases, the employee may value the benefit more highly than the tax cost. It can also be a strong recruitment and retention tool.
From the employer’s point of view, private medical insurance may cost less than providing an equivalent salary increase, while still being highly valued by the employee.
The important point is to look at the overall value to the employee, not just whether the benefit is taxable or tax-free.
Training and professional development
Training is often one of the most overlooked ways to reward employees. Funding qualifications, courses, professional subscriptions or technical training can be really valuable to employees who want to progress.
It also benefits the business by improving skills and capability within the team.
For ambitious employees, support with training may be more meaningful than a small increase in take-home pay.
Bonuses, salary and directors
For owner-managed businesses, remuneration planning can become even more important where the individual is also a director or shareholder.
In those cases, the options may include salary, bonuses, dividends, pension contributions, benefits, or a combination of these.
The right answer will depend on the company’s profits, cash flow, share structure, personal tax position, pension position and future plans. It’s also important to distinguish between employees and directors or shareholders. What works for one person may not be appropriate for another.
A practical example
We recently discussed this type of issue with a business owner who wanted to reward a valued team member.
The planned pay rise would have pushed the employee into higher rate tax, meaning the employee may not have received as much net benefit as the employer expected.
Rather than simply looking at gross salary, we discussed whether a combination of salary, pension contributions and other benefits could provide better overall value.
That’s the point – this is not about avoiding tax. It’s about structuring remuneration properly, so the business rewards people in a way that’s commercial, compliant and provides the most value.
Things employers should consider
Before changing how an employee is rewarded, business owners could consider:
- What does the employee actually value?
- Will the benefit create a taxable Benefit-in-Kind?
- Does the arrangement need to be reported through payroll or on a P11D?
- Could salary sacrifice affect pensionable pay, mortgages or statutory payments?
- Is the arrangement properly documented?
- Does it apply fairly across the team?
- What’s the cost to the business?
- What’s the real value to the employee?
The most tax-efficient option is not always the best option – the right approach is usually a balance between tax, cost and employee value.
Final thoughts
For employees approaching higher rate tax, or affected by income-related thresholds, a wider benefits package may provide better overall value.
Pension contributions, mobile phones, electric vehicles, additional leave, training, healthcare and staff perks can all form part of a more thoughtful reward strategy.
For business owners, this can also help with staff retention, morale and long-term planning.
At Seavor Chartered, we help business owners think practically about payroll, tax, remuneration and employee benefits.
If you are considering pay rises, bonuses, or benefits for your team, it’s worth reviewing the options before making changes. A short conversation in advance can often help avoid unexpected tax consequences and make sure the reward is structured in the best way for both the business and the employee.
