With employment costs continuing to rise and competition for skilled employees remaining strong, many businesses are looking for ways to increase the value of their benefits package without significantly increasing payroll costs.
One option worth considering is salary exchange, which can sometimes be referred to as salary sacrifice. When implemented correctly, it can create financial benefits for both employers and employees, while supporting long-term financial wellbeing and helping businesses attract and retain talent.
What is salary exchange?
Salary exchange is an arrangement where an employee agrees to reduce their contractual salary in return for a non-cash benefit provided by their employer.
The most common example is pension salary exchange. Instead of the employee making pension contributions from their salary, they agree to give up part of their salary and the employer pays the equivalent amount directly into their pension.
Because the exchanged amount is removed from salary before National Insurance is calculated, both the employer and employee can make savings.
How does salary exchange work?
Let’s look at a simple example.
An employee earning £35,000 a year contributes £200 a month (£2,400 a year) to their pension.
Without salary exchange, both the employee and employer pay National Insurance on the full £35,000 salary.
With salary exchange, the employee agrees to reduce their salary to £32,600, and the employer pays the £2,400 pension contribution directly into the pension instead.
This means:
- The employee pays National Insurance on £32,600 instead of £35,000.
- The employer pays National Insurance on £32,600 instead of £35,000.
- The pension still receives the full £2,400 contribution.
This may result in National Insurance savings for both the employee and employer, depending on individual circumstances and prevailing tax rules.
Why employers are using salary exchange
While the National Insurance savings are often the initial attraction, many employers find the wider benefits equally valuable.
Reducing employer National Insurance costs can create ongoing savings for the business, particularly across larger workforces. Those savings can then be reinvested into pensions, employee benefits or wider wellbeing initiatives.
Salary exchange can also strengthen an organisation’s employee proposition. Job seekers are increasingly looking at the overall reward package rather than focusing solely on salary, and well-structured benefits can help employers stand out in a competitive recruitment market.
For many businesses, salary exchange also demonstrates a commitment to supporting employees’ long-term financial wellbeing by helping them save more efficiently for the future.
What are the benefits for employees?
Employees can benefit from paying less National Insurance because their contractual salary is reduced under the arrangement.
In the case of pension salary exchange, employees may also be able to increase the amount invested in their pension while maintaining a similar level of take-home pay. Over time, this can make a meaningful difference to retirement savings.
Salary exchange can also be used to support a range of benefits beyond pensions, including electric vehicle schemes, Cycle to Work programmes and additional life assurance cover, allowing employees to access valuable benefits in a more cost-effective way.
What should employers consider?
Although salary exchange can offer significant advantages, it is important to ensure any arrangement is suitable for both the business and its employees.
Employers should consider the impact on employment contracts, statutory payments and National Minimum Wage requirements, as well as the practical payroll administration involved. Clear communication is also essential so employees understand how the arrangement works and what it means for their individual circumstances.
Is salary exchange right for your business?
Salary exchange is about more than simply reducing tax or National Insurance costs. It can be an effective way to enhance employee benefits, support financial wellbeing and make your overall reward package more attractive.
At a time when many organisations are balancing rising costs with the need to recruit and retain talented people, salary exchange can provide a practical way to deliver greater value for both employers and employees, depending on their circumstances.
Our workplace save + protect team supports businesses and employees to help them understand how salary exchange, pension planning and employee benefits can support their wider financial goals.
What does the proposed £2,000 cap mean for the future of salary exchange?
The Government has announced that changes to pension salary exchange arrangements are due to take effect from 6 April 2029. Under the new rules, the National Insurance savings associated with salary exchange will be limited to the first £2,000. The £2,000 cap will not restrict how much can be sacrificed into a pension; and pension contributions above this level will continue to benefit from tax relief.
Whilst the proposed cap may reduce the National Insurance savings available to employers, the vast majority of employees are unlikely to be affected by the change. Most workplace pension members contributing at the standard auto-enrolment level (5%) are expected to remain comfortably within the £2,000 threshold. Looking forwards employers can continue to add value working alongside financial advisers to make sure employees feel supported to make use of the allowances available.
Get in touch
For further information or advice on salary exchange, contact our workplace save + protect team by emailing enquiries@pmm.co.uk or calling 01254 679131.
This article is for general information only and does not constitute personal, financial, tax, legal or regulated financial advice. Salary exchange may not be suitable for everyone, and the benefits will depend on individual circumstances and tax rules, which may change in the future. Employers and employees should seek professional advice before taking any action. Pension benefits are not guaranteed, and the value of investments can fall as well as rise.
