Salary sacrifice is an arrangement where you agree to give up part of your salary in exchange for your employer making additional pension contributions on your behalf. Because the sacrificed amount is never paid to you as salary, it avoids both Income Tax and National Insurance — making it more tax-efficient than personal pension contributions.
How It Works
Under a salary sacrifice arrangement:
- You agree with your employer to reduce your contractual salary by a specified amount
- Your employer pays that amount directly into your pension as an employer contribution
- You no longer pay Income Tax or employee NI on the sacrificed amount
- Your employer no longer pays employer NI on the sacrificed amount
This differs from a personal pension contribution, where you pay from net salary and receive tax relief but still pay National Insurance on the full salary.
The NI Advantage
The key benefit of salary sacrifice over personal pension contributions is the National Insurance saving:
| Method | Income Tax Saved | Employee NI Saved | Employer NI Saved |
|---|---|---|---|
| Personal pension contribution | Yes (via relief) | No | No |
| Salary sacrifice | Yes | Yes (8% or 2%) | Yes (15%) |
For a Higher Rate taxpayer earning £60,000 who sacrifices £5,000:
- Income Tax saved: £2,000 (40%)
- Employee NI saved: £100 (2% above UEL)
- Employer NI saved: £750 (15%)
The employer NI saving of £750 often gets shared with the employee — either as additional pension contributions or as a cash top-up — though employers are not required to do so.
Impact on Other Benefits
Reducing your contractual salary through sacrifice can affect:
- Mortgage applications: Lenders may assess you on your reduced salary, though many now accept the higher pre-sacrifice figure
- State benefits: If your salary drops below certain thresholds, entitlements like Statutory Maternity Pay or Statutory Sick Pay could be affected
- Student loan repayments: Repayments are based on actual salary, so sacrifice reduces them
- Life insurance and death-in-service: Benefits linked to salary may be calculated on the reduced figure — check your scheme
Your employer should not allow salary sacrifice to reduce your pay below the National Minimum Wage.
Salary Sacrifice and the 60% Tax Trap
Salary sacrifice is particularly powerful for earners in the £100,000–£125,140 range who face the 60% effective marginal rate due to the Personal Allowance taper. Sacrificing salary to bring adjusted net income below £100,000 can save 60% in tax plus 2% in NI on the sacrificed amount — a combined marginal saving of 62%.
Because salary sacrifice reduces gross pay before it reaches you, it directly reduces adjusted net income. Personal pension contributions achieve the same Income Tax result but do not save National Insurance.
Annual Allowance
Whether contributed via salary sacrifice or personally, pension contributions count toward the £60,000 Annual Allowance (or your tapering allowance if applicable). Exceeding the allowance triggers a tax charge, so track your total contributions carefully.
Key Takeaway
If your employer offers salary sacrifice for pension contributions, it is almost always the most tax-efficient way to save for retirement. Ask your employer whether they share the employer NI saving — this alone can boost your pension pot by hundreds or thousands of pounds each year.