How Salary Sacrifice Works

Summary

Salary sacrifice is an arrangement where an employee gives up part of their contractual salary in exchange for a non-cash benefit, most commonly an employer pension contribution. Because the sacrificed amount is never received as salary, it is not subject to income tax or employee National Insurance, creating a tax saving compared to receiving the salary and then contributing to a pension personally.

How it works

The mechanism

In a standard pension contribution, you earn your gross salary, pay tax and NI on it, and then contribute to your pension (with tax relief added back). With salary sacrifice:

1. Your contractual salary is permanently reduced by the sacrifice amount
2. Your employer pays the sacrificed amount directly into your pension
3. You pay income tax and NI only on the reduced salary
4. Your employer also saves on employer NI (15% from April 2025)

Tax savings comparison

For a £50,000 earner sacrificing £5,000 into a pension:

Without salary sacrifice (relief at source):

• Gross pay: £50,000
• Employee pension (5% post-tax): £4,000 gross into pension (£3,200 from salary + £800 tax relief)
• Income tax on £50,000: varies, but NI on full salary

With salary sacrifice:

• Contractual salary reduced to £45,000
• Employer pension contribution: £5,000
• Income tax and NI calculated on £45,000 only
• Employee NI saving: £5,000 x 8% = £400
• Employer NI saving: £5,000 x 15% = £750

The employee NI saving (8% or 2% depending on band) is the key advantage of salary sacrifice over relief at source.

Eligible benefits

Salary sacrifice is HMRC-approved for:

• Pension contributions (most common)
• Cycle to work schemes
• Ultra-low emission vehicles (electric cars)
• Childcare vouchers (legacy schemes)
• Workplace nurseries

It cannot be used to reduce salary below the National Minimum Wage.

Worked example

Salary: £60,000, sacrificing £6,000 for pension

1. New contractual salary: £54,000
2. Income tax saved: £6,000 x 40% = £2,400 (same as relief at source for higher-rate payer)
3. Employee NI saved: £6,000 x 2% = £120 (above upper earnings limit)
4. Employer NI saved: £6,000 x 15% = £900
5. Total NI saving: £1,020
6. Pension pot receives: £6,000 (full amount, no leakage to NI)

With relief at source, the employee would pay NI on the £6,000 before contributing, losing the £120 employee NI saving.

Upcoming changes (April 2029)

From April 2029, the NI exemption for salary sacrifice pension contributions will be capped at £2,000 per year. Amounts above £2,000 will be subject to both employee and employer Class 1 NICs. This significantly reduces the advantage for higher earners making large pension contributions.

Inputs explained

• Gross salary — your current annual salary before sacrifice
• Sacrifice amount or percentage — how much to sacrifice for pension
• Tax year — determines rates and thresholds

Outputs explained

• New contractual salary — your reduced gross pay after sacrifice
• Take-home pay comparison — net pay with and without salary sacrifice
• NI saving — the additional tax saving from salary sacrifice vs relief at source
• Pension contribution — the total amount going into your pension
• Employer NI saving — often shared with the employee or added to pension

Assumptions & limitations

• Salary sacrifice permanently reduces your contractual salary, which can affect mortgage applications (lenders may assess the lower salary), maternity pay (SMP is based on actual earnings), and death-in-service benefits.
• The calculator assumes the employer passes on their NI saving as an additional pension contribution. Some employers retain this saving.
• Cannot reduce salary below the National Minimum Wage (£12.21/hour from April 2025).
• After April 2029, amounts above £2,000 will lose the NI advantage, making the calculation more complex for large contributions.