Salary Exchange For Pensions (or Paying Less Tax With The Approval Of HMRC)

Quick facts that will undoubtedly be useful for the next pub quiz you attend…

Income Tax was first introduced as a temporary measure in 1799 to fund the Napoleonic Wars. It became a permanent fixture in 1907.

National Insurance was introduced in 1911 and was, initially, a system of insurance against illness and unemployment.

It is now 2018 (I’d be mildly surprised if this would ever be the answer to a question in a pub quiz, but bear with me).

More than 100 years after their introduction, we generally accept without question what we pay. Indeed, we are mildly grateful if the Chancellor increases the Personal Allowance above the level of inflation, for example.

But what if The Chancellor came knocking at your door and asked you “Would you like to pay less tax?” and added “With my approval?”. How many people would say no?

And yet we can and don’t.

Many pension schemes are still run without the benefit of Salary Exchange. This used to be called Salary Sacrifice, conjuring up images of losing your first born on some prehistoric altar to appease the gods and increase the harvest. Following a review by HM Revenue & Customs a few years ago, the new concept of Salary Exchange was born – far fewer images of infanticide and much more of a concept of getting something back rather than just giving it up.

So, how does it work in relation to a pension scheme?

Well, the non-Salary Exchange route sees an employee get their full basic salary. From there, Income Tax and National Insurance are deducted, and from the resulting net figure a pension contribution is taken.

Under Salary Exchange, the order changes. The first deduction from gross salary is the gross pension contribution. From the resulting figure, Income Tax and National Insurance are deducted.

The result is no change in the Income Tax bill (see below for higher rate taxpayers) but savings for both employee and employer on National Insurance.

Just before I put the above into figures to demonstrate the savings that can be achieved, can I remind you (as if you needed it) that minimum pension contribution levels are increasing this month and will go up again in April 2019.

So, let’s consider an employee on £40,000 a year who has a standard Personal Allowance of £11,850 and is a member of a Workplace Pension where contributions are being paid at the statutory minimum levels.

From April 2018 to March 2019, the employee will have £144 more in take-home pay by using Salary Exchange and the employer will pay £165.60 less in National Insurance. There is no change in the overall pension contribution amount.

Multiply this out by the number of employees on payroll and the numbers quickly become substantial. Employers can choose to keep the National Insurance saving. Or they could rebate some to employees by way of an increased pension contribution. Or they could use it to pay some or all of the cost of additional benefits – Group Life Assurance, for example.

And aside from the monetary savings there are a number of additional benefits of Salary Exchange: –

  • Higher rate taxpayers get their additional relief immediately and don’t have to complete a Self Assessment form to claim it back from HMRC
  • Student Loan payments are reduced
  • Couples who have their Child Benefit reduced may get some of this reduction back

Which leads me on to reasons why Salary Exchange might not be used. There are three common obstacles put up here: –

  • “I won’t be able to get as big a mortgage because my gross salary is lower as a result of Salary Exchange” – in the old days, mortgage lenders would look at an individual’s gross earnings, multiply it by 3 or 4 and that was the maximum amount of mortgage you could get. Following the financial crisis in 2007/8 the Bank Of England tightened lending rules and mortgage amounts were based on a proportion of net income. As Salary Exchange increases net income, it follows that available mortgage amounts should be higher.
  • “My State Pension will be lower” – this might have been true before 2016 when State Pension included an earnings element (SERPS and State Second Pension being the main two). Since April 2016, the move to a Flat Rate State Pension i.e. one that is based solely on the number of years of National insurance contributions, means that this argument doesn’t hold either.
  • “I’m a non-taxpayer” – this is the one scenario in which Salary Exchange won’t work. Non-taxpayers still get basic rate tax relief on contributions provided they are taken from net pay. A non-taxpayer or someone who is taken out of tax as a result of Salary exchange will lose out.

Notwithstanding the above, Salary Exchange is a win-win in the vast majority of cases. Employees get more take-home pay. Employers pay less National Insurance.

So, why aren’t you making the most of it?

We have helped many employers make the most of Salary Exchange and continue to do so. To benefit from what we have already learned, don’t hesitate to call us on 0333 241 3350 or email


This information is provided strictly for general consideration only. No action must be taken or refrained from based on its contents alone. Accordingly, no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case. All statements concerning taxation are based on our understanding of the current law and HMRC practice, and proposed changes, as at the date of publication.