What is Salary Exchange?
Salary exchange is an agreement between you and your employer. You agree to exchange part of your gross (before tax) salary in return for a non-cash benefit, like a pension contribution.
How does it work?
Firstly your employer must be offering salary exchange through your pension scheme. Then, if you decide to take advantage of the salary exchange agreement, this involves a change to your terms and conditions of employment. You may be required to actively sign up to salary exchange or your employer may set a date for salary exchange to automatically apply, in which case you must tell your employer if you don't want to participate. You will choose an amount of money to exchange and your gross salary is then reduced by this amount.
For example, if an employee earns £25,000 each year and chooses to exchange £2,500, their salary would become £22,500. The exchanged amount, is then paid direct to their pension plan as an employer contribution.
What this could mean for you
By making pension contributions through salary exchange rather than directly you would effectively reduce the amount of National Insurance contributions that you pay. This can result in two scenarios:
- Keeping your take-home pay the same and increase the amount paid into your pension plan.
- Keeping your pension contributions the same and increase your take-home pay
Things to consider
As salary exchange is a change to your contract of employment, it is a legally binding agreement and you should ensure that it’s the right thing for you to do before agreeing to it. Normally you can’t change or stop the exchange during the agreement period. Here are some of the things that you should think about which may be impacted if you choose to exchange some of your salary in this way.
- Benefits which are directly related to your salary, for example, life cover
- State benefits which are impacted by the National Insurance contributions that you pay
- Mortgage providers usually use multiples of the borrower’s salary to calculate the amount they will lend
- You can’t allow your take-home earnings to fall below the national minimum wage as a result of salary exchange.
For more information and for examples of how salary exchange can work please read our Salary Exchange Flyer.
Want more information?
For more information about salary exchange please contact your employer or seek financial advice.