Put simply, it’s an agreement between you and your employer where you exchange part of your gross salary for a pension contribution. It works in the same way as other salary-related benefits you might get, like company car, cycle to work and childcare voucher schemes.

When it comes to your workplace pension, the main benefit is you pay less income tax, and you and your employer pay less National Insurance Contributions (NIC). This is because your salary is reduced before tax and NIC are taken.

Let’s look at an example for Sam. Sam pays basic rate tax and earns £2,250 a month. They pay 5% of their salary into their pension and their employer also pays in 3%.

  • Sam agrees to exchange £112.50 of their salary each month
  • Because Sam’s salary is reduced, they save £37.41 in tax and NIC
  • The £112.50 Sam exchanges is added to their employer’s contribution of £67.50, so £180 is paid into their pension each month.

We’ve used the above figures as an example to show you how salary exchange works based on tax and National Insurance rates for the 2022/23 tax year. You should speak to your employer to find out more about your own pension contributions, and how much they’re paying in.

Remember, the tax you pay depends on your individual circumstances and where you live in the UK and may change in the future.

Is salary exchange right for you?

Paying into a pension using salary exchange might not be right for everyone. Here’s some things to think about:

  • You won’t be able to exchange part of your salary if it means it’ll drop below the National Minimum Wage or National Living Wage
  • As your salary reduces when you agree to exchange part of it, it could affect your entitlement to other benefits like statutory sick pay. You should speak to your employer for more information about this
  • If you’re a higher rate taxpayer you could benefit from higher tax and NIC savings
  • Salary exchange used to affect how much you could borrow for a mortgage, however most lenders will now typically lend based on your salary before you exchange part of it
  • The rules about salary exchange may change in the future. If you’re not sure if salary exchange is right for you, it’s a good idea to speak to a financial adviser.