Salary Exchange

a fantastic financial opportunity to boost your pension fund – at no extra cost

Salary Exchange, or Salary Sacrifice as it is also known, has existed for over 20 years and is a fantastic way to boost the amount going into employees’ Defined Contribution pension funds.

What is Salary Exchange?

A Salary Exchange happens when an individual agrees to forego the right to an amount, or proportion, of their pay through a change in the Terms and Conditions of their employment. In return, their employer provides them with an additional employee benefit.

In foregoing pay, prior to receipt, an individual using Salary Exchange benefits from a reduction in both their Income Tax and National Insurance Contributions (NIC) deductions, and similarly the employer also sees their NIC fall.

Because a Salary Exchange agreement reduces these payments it is important to be aware that putting such agreement in place can impact on some State Benefits or Credits. For example, Statutory Sick Pay, Statutory Maternity Pay and State Second Pension payments may be reduced while Child Tax Credits may be increased. It is important that anyone considering starting a Salary Exchange agreement considers the impact of this on such benefits and credits.

What use is Salary Exchange?

Salary Exchange exists as a method of accessing a wide range of employee benefits such as Childcare Vouchers, Cycle to Work schemes and Health Screening, as well as Pensions.

With the reduction in Income Tax and NICs, benefits are cheaper or more can be invested, as the cost is met from Gross Pay prior to deductions rather than Net Pay after deductions.

This cost advantage is increased further if the employer rebates part or all of the NICs which they save.

The primary usage has been and continues to be for pension contributions. In this case, it is total investment into the pension fund which is significantly greater than it would otherwise have been through alternative methods of paying in contributions.

Why is it so attractive for pension contributions?

It is the increased investment into the pension plan which makes paying contributions by Salary Exchange so beneficial.

Take for example a basic rate tax payer, paying the lower rate of NIC, and wanting to pay a net contribution of £100 per month into the employer’s Group Personal Pension plan. To do so through the normal methods of payment available to them would see this £100 payment increase to £125 on investment through the addition of basic rate tax relief at source.

By putting in place a Salary Exchange agreement which has the result of reducing net pay by the same £100 per month, the total pension investment increases to £167.38, assuming the employer rebates into the pension plan their NIC too.

In effect, for the same personal cost the individual with the Salary Exchange agreement has received a 33% increase in pension investment and so is immediately on target for a greater income and/or Tax Free Cash payment in retirement.

What else should be considered in respect of Salary Exchange?

A Salary Exchange agreement effectively alters and individual employee’s Terms and Conditions of Employment. As such, as well as the impact on State Benefits and Credits, it should be noted that to stop such an arrangement would require renegotiation of these Terms and Conditions with the employer.

By reducing Gross Pay other employee benefits may be affected, for example, the rate at which overtime is paid or bonuses are calculated. Similarly, such agreement may mean that Death in Service or Income Protection benefits are based on lower earnings than they would otherwise have been.

Solutions exist to all of these issues, and others, through the use of Contractual and Notional Salaries.