What is salary sacrifice?
Salary sacrifice, sometimes known as salary exchange, is an arrangement that employers can make available to employees; the employee agrees to a reduction in their salary or bonus, and the employer provides another benefit to them instead. In this article, we focus on ‘swapping’ salary for pension contributions.
What are the benefits?
In short, everyone pays out less tax.
As the employee is sacrificing part of their salary, both employer and employee pay less in national insurance (NI). With the employer’s rate of NI increasing to 15% from 6th April 2025, this could be particularly beneficial. The employee will also pay less income tax.
Instead of an employee contributing 5% of their salary and the employer contributing 3% towards the pension, under salary sacrifice the employee will sacrifice 5% of their salary and the employer will contribute the full 8%. This is classified as an employer contribution because they are paying the full contribution (including the 5% amount sacrificed by the employee).
In addition to saving income tax on the money sacrificed, the employee will save 8% NI and the employer 15% NI.
As the pension contribution is effectively an employer contribution, the employer can pay the full employers’ NI saving into the employees’ pension pot. Some employers choose to pay the full amount in, others choose 10% or any other figure down to zero. In essence, the employer can ‘pass on’ as much or as little of the 15% employer’s NI saving as they want, to the employee.
There are several potential benefits:
- Employees and employers can pay the tax savings into the employee’s pension pot – helping them save even more for the future.
- Employees can increase their take-home pay.
- Employers can offer an improved benefits package to their employees.
- Employers can reinvest the money they’ve saved back into the business.
Let’s take a look at these savings in action.
Employer savings
The figures in the following example are based on 2025/26 tax year rates – the tax year about to begin in around three weeks’ time. They assume an average annual salary of £30,000 for each employee, with each employee contributing the legal minimum of 5% to their pension calculated against their total earnings:
Salary sacrificed by the employee(s) | Employer NIC rate | Employer’s yearly NIC savings | |
1 scheme member | £1,500 | 15% | £225 |
50 scheme members | £75,000 | 15% | £11,250 |
500 scheme members | £750,000 | 15% | £112,500 |
The savings generated can be reinvested into the business, allocated to employees to enhance their pension pots (thereby improving retirement outcomes), or a combination of these options.
Employee savings
The calculations below compare the outcomes of an employee contributing to their pension through relief at source, net pay and salary sacrifice arrangements in the 2025/26 tax year. In this example, the employee earns a gross salary of £30,000 a year and contributes the legal minimum of 5% to their pension calculated against their total earnings:
Relief at source | Net pay | Salary sacrifice | |
Gross annual salary | £30,000 | £30,000 | £30,000 |
Employee pension contribution | N/A | £1,500 | £1,500 |
Total taxable salary | £17,430 | £15,930 | £15,930 |
Income tax (IT) paid | £3,486 | £3,186 | £3,186 |
Employee NIC | £1,394 | £1,394 | £1,274 |
Employee pension contribution | £1,200 | N/A | N/A |
Net annual salary | £23,920 | £23,920 | £24,040 |
While the value of the annual pension contribution remains unchanged in these examples, deducting them before calculating income tax (IT) and NI via salary sacrifice reduces the tax and NI paid. As a result, the employee’s take-home pay increases by £120 a year (or £10 a month). This additional money can be added to their pension pot as a tax-efficient way to boost their retirement savings.
Setting up salary sacrifice
Employers can offer salary sacrifice to all employees, as long it doesn’t reduce their salary to below minimum wage. From 1st April 2025 the minimum wage is £12.21 per hour for employees over the age of 21, known as the National Minimum Wage. Salary sacrifice can’t take earning below the lower earnings threshold.
Getting set up in just a few simple steps:
- Employers should get in contact with Payroll to see if they can facilitate salary sacrifice for the employer’s pension scheme.
- Employees will need to agree to the change in their contract or through an agreement letter. Employers will need employees’ permission before entering them into a salary sacrifice scheme. If they don’t agree to salary sacrifice, employers will need to take their employees’ pension contributions in the usual way.
- Once the employer has received their employee’s permission, they can set up the salary sacrifice scheme through their payroll.
Make sure it’s right for you
Salary sacrifice won’t be for everyone, so there are a few things to consider before setting it up:
- Employees may receive lower life cover as well as lower borrowing available on loans and mortgages. This is because of a lower take-home income. However, most providers will take salary sacrifice into consideration.
- Employees’ entitlement to state benefits e.g. Statutory Maternity Pay and the State Pension may be affected if their salary falls below the level at which they pay National Insurance contributions.
- Salary sacrifice affects the employee’s terms and conditions of employment and is a matter of employment law, not tax or pensions law.
Please get in touch if you want to learn more.
