Frequently asked questions about salary exchange

Salary exchange, or salary sacrifice, is when:

• An employee agrees to give up some salary or bonus in exchange for a non-cash benefit, in this case a pension contribution.
• As the employee is paid less salary or bonus:
  • You save on National Insurance contributions.
  • Your employees pay less income tax and National Insurance.

Salary exchange isn't just for pensions, it's a mechanism for an employer to allow their employees to exchange part of their salary for non-cash benefits. While this does often include pension contributions, it's also frequently used for non-pension related options such as cycle-to-work schemes, technology purchase schemes and childcare initiatives.

We may be able to run a session to help your employees understand salary exchange. This would be reviewed on a case by case basis. Where it's not possible, we do run regular webinars covering a range of topics, including salary exchange.

Please speak to your Royal London contact.

Whether you're looking to set up salary exchange on an existing or new Royal London workplace pension scheme, there are a number of steps you need to take before Royal London can support. You'll find a list of these steps and details of how we can help on our Setting up salary exchange webpage.

There are a number of directories that can be used to search for financial advisers in your area.

As salary exchange involves a change to employment contracts, we also recommend seeking advice from an employment law specialist.

If you wish to proceed without financial advice, we can still set your employees up on a salary exchange arrangement. However, it's important to note that it's your responsibility to ensure all of the steps outlined in our Setting up salary exchange guide, have been actioned. 

Any changes required within your payroll system will vary by payroll provider. As a result, we're unable to support with this.

It can be used with any type of UK registered pension plan - such as individual or group personal pension/stakeholder or occupational money purchase/final salary schemes. The main point to remember is that you, the employer, must be willing and able to make contributions to the scheme after the exchange is made.

Yes, salary exchange can be introduced into existing schemes as well as new schemes.

If you have an existing pension scheme with pension contributions set up on a net pay or relief at source basis then switching to a salary exchange arrangement could increase pension contributions or take-home pay. Where the increase is applied depends on how you set up your arrangement and what you choose to do with both your employer National Insurance(NI) savings, and your employee’s NI and income tax savings.

You can use our salary exchange calculator to help demonstrate the following options at an individual employee level:

1. You choose to keep some or all of your employer NI savings and add your employee NI and income tax savings to their take-home pay.
2. You choose to keep some or all of your employer NI savings and add your employee NI and income tax savings to their pension contribution.
3. You reinvest some or all of your employer NI savings into your employees’ pension plans and add your employee NI and income tax savings to their take-home pay.
4. You reinvest some or all of your employer NI savings into your employees’ pension plans and add your employee NI and income tax savings to their pension plan.

As this is an employer decision, we're unable to provide advice or guidance on which option is best suited for your business. You should speak to your financial adviser.

No, the salary exchange calculation and income tax and National Insurance contribution savings are not affected.

As the contribution is now being paid by salary exchange, no income tax is deducted from the salary that has been given up. So, they effectively get their tax relief immediately and don't have to claim it through their tax return.

You can use your savings in a number of ways. For example, to increase pension contributions by adding your savings to your employees' plans, provide other employee benefits or simply keep the savings to invest in your business. Remember, the amount of salary your employee exchanges must be used to provide a non-cash benefit to the employee.

No, salary exchange constitutes a change to an employee's contract of employment, it's not within the remit of HMRC and they do not have to be advised.

However, HMRC is concerned that income tax and National Insurance contributions are deducted correctly. You have the option to contact HMRC if you want to make sure you're deducting income tax and National Insurance contributions properly after the salary exchange arrangement is in place. Details of how you can do this can be found in HMRCs: Salary Sacrifice and the effects on PAYE.

Yes it can normally be altered, for example, if someone opts out of an automatic enrolment scheme with salary exchange. For any other circumstances, it depends on how your agreement has been set up.

Yes, salary exchange can affect certain employer, state and other benefits, some of which are listed below - note that this list is not exhaustive. The impact on benefits can however be mitigated in certain circumstances.

More information on how salary exchange can affect benefits can be found in our guide to salary exchange and guide for employees.

Salary, overtime, bonuses and other employer related benefits

Although salary exchange is a reduction in gross salary, the agreement can be made so that salary increases, bonuses and overtime for example are based on the salary before the exchange. This is commonly known as 'notional' or 'shadow' pay.

Mortgages and other borrowing

Mortgage and other lenders may base the amount they're willing to lend on either a multiple of salary or affordability. You can provide lenders with details of an employee's pre-exchanged salary however this may not be accepted. Employees considering borrowing should therefore discuss this with their lender.

State Pension

Entitlement to both the basic and new State Pension is based on the number of 'qualifying years' in an individual's working life rather than the amount of National Insurance contributions. For a year to count as a qualifying year, earnings need to be above the Lower Earnings Limit, so care should be taken not to salary exchange below that level.

Statutory Maternity/Adoption pay

Statutory Maternity/Adoption Pay are based on gross earnings subject to Class 1 National Insurance contributions and income tax. As these earnings will reduce as a result of salary exchange, there'll be an impact on Statutory Maternity/Adoption Pay and they may also reduce.

If you operate an occupational Maternity or Adoption Pay policy, you can increase payments up to or above the pre exchange statutory amount to ensure your employee do not lose out.

Statutory Paternity Pay

If earnings are reduced to less than Lower Earnings Limit, there's no entitlement to Statutory Paternity Pay.

Statutory Sick Pay

Statutory Sick Pay is a work-related payment which employees are entitled to by law and is not connected to their contract of employment.

If earnings fall below Lower Earnings Limit then there's no right to receive Statutory Sick Pay. If this happens employees may still be entitled to Income Support or Employment and support allowance, if they meet the qualifying conditions.

If you operate an occupational sick pay scheme, sick pay could still be paid through that scheme even if earnings are less than Lower Earnings Limit to ensure your employees are not worse off.

Student loans

Repayments of student loans are triggered where earnings are above a certain level, which will depend on when the loan was taken out. If a salary exchange reduces earnings to below this threshold, repayments may reduce or stop. This may mean that it'll take longer to repay any student loan.

This should form part of your salary exchange agreement to ensure it's clear how and when employees can opt out.

In general, no, your employee can't exchange all of their salary so that their remaining salary is below the National Minimum Wage (NML) or National Living Wage (NLW).

HMRC - EIM42769 - Salary sacrifice: conditions for successful salary sacrifice: effectiveness of contractual arrangement

An exception to this is employee's who are directors. The NMW/NLW does not apply to a director if they are an office holder, this is because they are not treated as a worker. If that is the case, they could if they want, exchange their whole salary.

HMRC - NMWM05140 - Entitlement to National Minimum Wage: directors and office holders

No, HMRC will not give any guidance on the salary exchange agreement wording. 

The agreement is part of the employment contract, so it's best to speak to a lawyer or employment law specialist.

Some pension providers may provide example templates but as employment contracts are usually company specific, it makes sense to have a lawyer or employment law specialist draft the wording.

We aren't able to provide a template for employers to use as part of a salary exchange agreement, as this needs to be specific to the employer-to-employee relationship.

As outlined in our guide to setting up salary exchange, there are a number of different options you can use to update your employment contracts. These can include using an agreement letter, opt-out form, or a new contract of employment. If you need support with these documents, you should consult an employment law specialist. 

Unless the agreement is written in such a way that it stops at certain events such as parental leave or when long term sick leave starts, you should continue making the payments while your employee is being paid.

Remember that under the rules for parental leave, you're required to maintain your employee pension contributions at the level they were before they started parental leave. They should continue until paid parental leave ends.

As far as the auto enrolment rules are concerned, you must use the post-exchange salary to calculate whether or not minimum pension contributions have been met.

For example:

Pre-exchange salary is £50,000. Contributions are 3% employer and 5% employee (including tax relief). The employee wants to use salary exchange to make their £2,500 contribution. Their salary after exchange is therefore £47,500, meaning that the actual employer contribution of £4,000 (£1,500 + £2,500) represents 8.42% of the £47,500 salary, not 8%.

You'll therefore need to calculate in advance what level of exchange would result in the minimum contribution being met when measured against the post-exchange salary. Most providers require the minimum to be based on the pre-exchange salary, accepting that this results in the contribution then being more than the minimum required when measured against the post-exchange salary.

In the above example, the employer is making the minimum contribution and their employee is using salary exchange to make the employee contribution. It's unlikely that providers and/or the Pensions Regulator will allow the total required contribution to be funded by employee salary exchange. Employees must always be given the option to contribute via salary exchange or on a relief at source basis.