How payments are made

How does it work?

Salary exchange works like this:

1. You agree to exchange an amount of your gross salary equal to the gross pension contributions you would normally make
2. Your employer adds their payment
3. They put the total amount in your pension
4. Your salary exchange payment is treated and referred to as an employer payment

What does this mean for you?

Let's assume your salary is £25,000. You pay 5% of your basic pensionable salary as a pension contribution. But instead of paying £1,250 into your pension, you exchange £1,250 of your gross salary. You therefore pay less tax and National Insurance (NI).

Remember these figures are an example. How salary exchange works for you will depend on your payment and any future changes in NI rules. Laws and tax rules may change in the future. The information here is based on our understanding in April 2020. Your own circumstances also have an impact on tax treatment.

What are the benefits?

By agreeing to reduce your salary, you save on NI contributions and reduce the amount that’s subject to income tax.

You can use this NI saving to either:

• increase the amount that gets paid into your pension  - depending on how much of an increase you choose, your take home pay may remain the same as it would be if your payments were deducted from your after-tax earnings

             or

• receive a take home pay that’s higher than it would be if your payments were deducted from your after-tax earnings instead

Are there any disadvantages?

Salary exchange isn't right or available for everyone. It's a change to your terms of employment and could affect your state benefits, other company benefits or your ability to borrow. If you do not currently pay tax, it may not be the best option for you.

If you're not sure whether salary exchange is right for you, ask your employer or seek financial advice.

Please note: you won't receive tax benefits if your earnings are too low for you to be paying income tax.

Your payments will be deducted from your salary before you're taxed, which means you’ll pay Income Tax on a lower amount. It also means that your personal tax rate position is taken into account immediately.

For example, if you’re a basic rate taxpayer and you want to make payments of £100 a month, £100 is taken from your salary before your tax liability is calculated. You can normally expect to pay £20 less in tax as a result, although the tax benefit could vary depending on your personal circumstances.

Note – if your earnings are below the personal allowance for income tax you won’t benefit from tax relief on your personal contributions as you don’t pay income tax. However, this doesn’t affect the amount that is paid into your pension and you’ll continue to benefit from the money that your employer pays in.

Tax rules and limits may change in the future. The information here is based on our pension experts’ understanding in April 2020. Your own circumstances also have an impact on tax treatment.