Pension Salary Exchange (also known as Salary Sacrifice) is a tax-efficient way for employees to contribute to their workplace pension.
Pension Salary Exchange
Saving Employees & Employers National insurance
The arrangement reduces National Insurance (NI) costs for both employees and employers.
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How It Works
Employees agree to exchange a portion of their gross salary in return for an equivalent employer pension contribution. This works in a similar way to other Salary Exchange schemes, such as cycle to work or company car schemes.
The key benefit is that reducing gross salary also lowers National Insurance Contributions (NICs) for both the employee and the employer.
However, the terms “Salary Exchange” and “Salary Sacrifice” can be misleading—after all, no one wants to feel like they are taking a pay cut. Employees may hesitate, thinking,
“Why would I give up part of my salary just to save on National Insurance?”
But what if there were a way to increase an employee’s net income while also reducing the employer’s NI bill?
Example: How Salary Exchange Benefits Employees
For most employees, salary exchange should be seen as an easy way to increase take-home pay.
To achieve this increase in net income, the exchange should be structured so that it is equal to the current employee workplace pension contribution. This redirects the pension contribution from the employee (after NICs are taken) to the employer (before NICs are taken).
| Before Salary Exchange | After Salary Exchange | Result | |
|---|---|---|---|
| Gross Salary | £50,000 | £47,500 | Employee exchanges £2,500 of salary (equal to their usual pension contribution). |
| Employee Pension Contribution | £2,500 | £0 | The employer now contributes this amount for the employee instead. |
| Employer Pension Contribution | £1,500 | £4,000 | Increased by the amount the employee exchanged. |
| Total Pension Contribution | £4,000 | £4,000 | Stays the same. |
| Employee NIC Bill | £2,994 | £2,794 | Employee saves £200. |
| Employee’s Net Income | £37,520 | £37,720 | Net income increases by £200. |
| Employer NIC Bill | £5,645 | £5,300 | Employer saves £345. |
Outcome of using Salary Exchange for this employee
- The employee increases their net income by £200.
- The employer saves £345 in National Insurance.
Salary Exchange is straightforward and benefits both the employee and employer. Across a whole workforce, the savings for employers could be substantial.
Example: How Salary Exchange Benefits Employers
- The employer has 8 employees, earning between £30,000 – £100,000 a year.
- Employee pension contributions are set at 5% of base salary.
| Employee | Annual Salary | Pension Contribution / Salary Exchange | 24/25 Employer NIC Saving | Increase In Employee Net Pay |
|---|---|---|---|---|
| Employee 1 | £30,000.00 | £1,500.00 | £207.00 | £120.00 |
| Employee 2 | £40,000.00 | £2,000.00 | £276.00 | £160.00 |
| Employee 3 | £50,000.00 | £2,500.00 | £345.00 | £200.00 |
| Employee 4 | £60,000.00 | £3,000.00 | £414.00 | £60.00 |
| Employee 5 | £70,000.00 | £3,500.00 | £483.00 | £70.00 |
| Employee 6 | £80,000.00 | £4,000.00 | £552.00 | £80.00 |
| Employee 7 | £90,000.00 | £4,500.00 | £621.00 | £90.00 |
| Employee 8 | £100,000.00 | £5,000.00 | £690.00 | £100.00 |
| TOTAL | £520,000.00 | £26,000.00 | £3,588.00 | £880.00 |
Outcome of using Salary Exchange for this employer
- The employer saves £3,588 in employer NICs.
- The employees collectively increase their net income by £880.
In most cases, the benefits of Salary Exchange outweigh any drawbacks.
How Employers Set Up Salary Exchange
- Draft the Salary Exchange agreement
- Consult a solicitor to ensure compliance.
- Offer employees the opportunity to opt in
- Clearly communicate the benefits.
- Adjust payroll accordingly
- Reduce employees’ gross salaries by the agreed exchange amount.
- Contribute the exchanged amount to the workplace pension scheme
Considerations for Employers
- Compliance is essential
- Free online templates may not fully comply with UK employment law.
- Salary Exchange alters employment contracts, so proper procedures must be followed.
- Increased admin for HR & Payroll
- Employees may have questions, and handling documentation can be time-consuming.
- Not all employees will enrol
- If not well explained, employees may not understand the benefits, reducing uptake and potential savings.
Is Salary Exchange Right for Everyone?
Salary Exchange may not be suitable for everyone. Here are some key points to consider:
- Minimum wage restrictions
- Employees cannot reduce their salary below the National Minimum Wage.
- Impact on other benefits
- A lower salary may affect entitlement to benefits, such as statutory sick pay or statutory maternity, paternity or adoption pay.
- Mortgage applications
- Some lenders base affordability on gross salary, which may impact borrowing capacity.
- However, reductions in affordability are small and rare when only exchanging a small amount.
- Potential Policy Changes
- Salary exchange rules could change in the future.
Conclusion
Pension Salary Exchange is a win-win strategy for employees and employers. It increases take-home pay, boosts pension savings, and cuts National Insurance costs. However, proper implementation is key. Employees should assess their personal circumstances before opting in.
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