Salary Exchange

Salary Exchange (sometimes known as Salary Sacrifice) is an agreement between employer and employee, where the employee agrees to a reduction in their salary to for other non-cash benefits from their employers including pension contributions, childcare vouchers, bus passes etc.

At its most basic, everyone pays less tax and exchanges this for access to other benefits. As employees’ gross wages are smaller, they pay less income tax and National Insurance (NI), and the employer saves on NI too. Employees may be hesitant to reduce their pre-tax salary, but there are benefits for both employee and employer.

With Salary Exchange, employees and employers can pay tax savings into the employee’s pension pot – helping them increase their retirement savings. Employers could choose to improve (or create) their employee benefits package thanks to these savings.

Every employee between 22 and the State Pension age who earns more than £10,000 each year should be enrolled into a workplace pension scheme. Switching to Salary Exchange for all of these employees can be complicated and costly as employment contracts will need to be amended and payroll updated.

To complicate matters further, employees are able to opt in and out – and this will affect their terms of employment, which must be kept up to date.

• Employee retention – When employees value benefits their workplace provides, employee retention and workplace wellbeing can improve. This is only possible when employees understand the benefits available, which is where financial education can help.
• Reduced National Insurance – As we’ve mentioned, Employers National Insurance contributions can be reduced with Salary Exchange. This can allow employers to offer other non-cash benefits such as pension contributions, childcare vouchers, cycle-to-work schemes, technology and company car schemes.

Employees should consider what a reduced gross salary could mean for them. Salary Exchange can affect the amount of cash they receive each month, how much they can borrow (as credit providers calculate this on salary), and other earning related benefits including their State Pension, Life cover and maternity pay.

Employees can also decide how much they would like to exchange, but this will depend on their employment contract, and their take home salary must not fall below minimum wage.

Faster growing pensions – Employees can use Salary Exchange to increase the total contributed to their pension each month. This can lead to a higher retirement income, and a better future quality of life.

Access to more benefits – Workplace schemes can allow employees to access a range of benefits they otherwise would not be able to afford such as Life Assurance or Critical Illness Cover.

Salary Exchange is not mandatory, and employees can opt out at any time. However, if employees are making use of non-cash benefits like the cycle-to-work scheme, they may have to pay off the balance of the agreement, or the value of the bike, depending on the plan details.

It is not mandatory for employers to provide Salary Exchange (Salary Sacrifice) schemes, or for employees to participate.

Tax does not need to be paid on the salary that is sacrificed – but the employee’s tax treatment can change. As employees surrender a portion of their salary for other benefits, this can affect their income tax rate and eligibility for other benefits.

Salary Exchange cannot be used to reduce an employee’s salary to less than minimum wage.

Employees can also decide how much they would like to exchange, but this will depend on their employment contract, and their take home salary must not fall below minimum wage.

Eligible employees must be enrolled in their employer’s workplace pension. It is mandatory for the employer to offer this, but the employee can opt out of a workplace pension. For Salary Exchange, employers need to ask employees if they wish to be part of the exchange arrangement. These are two separate arrangements, working together.

Salary Exchange is not available if you are self-employed unless you are a Company Director of your own limited company and pay yourself dividends. We recommend anyone who is self-employed, who naturally has more complex pension arrangements, to get in touch with us for financial advice.

Employees do not pay tax (including National Insurance) on the exchanged amount.

Whether an employee will receive a state pension depends on their National Insurance record, so it is possible that this could affect your eligibility.