Salary Sacrifice Pension: How It Works and NI Savings Explained
Learn how salary sacrifice (salary exchange) for pensions works. Calculate your NI savings as an employer and understand the benefits for employees.
What Is Salary Sacrifice for Pensions?
Salary sacrifice (also known as salary exchange) is an arrangement where an employee agrees to give up a portion of their gross salary in return for an increased employer pension contribution of the same amount. Rather than the employee receiving the salary and then having a pension deduction taken, the employee’s contractual pay is reduced before tax and National Insurance are calculated. The employer then pays the sacrificed amount directly into the employee’s pension scheme as an employer contribution.
This is not the same as a standard employee pension contribution. Under a normal arrangement, an employee contribution is deducted from net pay (or, with relief at source, the pension provider reclaims basic-rate tax). With salary sacrifice, the contribution never forms part of the employee’s taxable pay at all, which creates savings on both Income Tax and National Insurance Contributions (NICs) for the employee — and crucially, NIC savings for the employer too.
How Salary Sacrifice Works Mechanically
The process involves a formal change to the employee’s contract of employment. Here is the step-by-step mechanism:
- The employee agrees to reduce their gross contractual salary by a set amount or percentage.
- The employer increases its pension contribution by the same amount, so the employee’s total pension contribution remains unchanged (or increases, if the employer passes on some of its NIC saving).
- Because the employee’s gross salary is now lower, both the employer and employee pay less National Insurance on that portion.
- The employee also pays less Income Tax, since the sacrificed amount is no longer part of their taxable earnings.
- PAYE is run on the reduced salary figure, and the employer remits the higher pension contribution directly to the pension provider.
For example, if an employee earning £30,000 sacrifices 5% (£1,500) of their salary, their new contractual salary becomes £28,500. The employer then contributes an additional £1,500 to the pension on the employee’s behalf, on top of any existing employer contribution.
NI Savings for Employers
From April 2025, employers pay Class 1 secondary NICs at 15% on earnings above the secondary threshold (£5,000 per year for 2026/27). When an employee sacrifices salary, the employer no longer has to pay 15% NIC on the sacrificed amount.
This means that for every £1,000 an employee sacrifices, the employer saves £150 in NICs. Across a workforce of even modest size, these savings can be substantial. Many employers choose to share some or all of this saving with employees by topping up the pension contribution further, making the scheme even more attractive.
NI and Income Tax Savings for Employees
Employees also benefit from reduced NICs. For 2026/27, employee Class 1 NIC rates are:
- 8% on earnings between the primary threshold (£12,570) and the upper earnings limit (£50,270).
- 2% on earnings above £50,270.
If the sacrificed salary falls within the 8% band, the employee saves 8p in NIC for every £1 sacrificed. On top of that, because the salary reduction happens before PAYE, the employee also saves Income Tax at their marginal rate — 20% for basic-rate taxpayers, 40% for higher-rate taxpayers, or 45% for additional-rate taxpayers.
Combined, a basic-rate taxpayer saves 28% (20% tax + 8% NIC) on every pound sacrificed in the main NIC band. A higher-rate taxpayer saves 42% (40% + 2%) on earnings above £50,270, or 48% (40% + 8%) on the portion that falls in the main NIC band.
Under a normal employee pension contribution with relief at source, employees only receive tax relief — they still pay full NICs. Salary sacrifice therefore provides an additional NIC saving that is not available through the standard route.
Worked Example: £30,000 Salary with 5% Pension Contribution
Let’s compare a standard employee pension contribution against salary sacrifice for an employee earning £30,000 with a 5% (£1,500) pension contribution. We assume the employer contributes 3% (£900) regardless of method.
Without Salary Sacrifice (Relief at Source)
| Item | Amount |
|---|---|
| Gross salary | £30,000 |
| Employee pension contribution (5%) | £1,500 (deducted from net pay; £1,200 from employee + £300 tax relief at source) |
| Taxable pay | £28,500 (after basic-rate relief) |
| NIC-able pay | £30,000 (full salary) |
| Employee NIC (8% on £17,430) | £1,394.40 |
| Income Tax (20% on £15,930) | £3,186.00 |
| Take-home pay (approx.) | £24,219.60 |
| Employer NIC (15% on £25,000) | £3,750.00 |
With Salary Sacrifice
| Item | Amount |
|---|---|
| Original gross salary | £30,000 |
| Salary sacrificed (5%) | £1,500 |
| New contractual salary | £28,500 |
| Employee pension contribution | £0 (now an employer contribution) |
| Taxable pay / NIC-able pay | £28,500 |
| Employee NIC (8% on £15,930) | £1,274.40 |
| Income Tax (20% on £15,930) | £3,186.00 |
| Take-home pay (approx.) | £24,039.60 |
| Employer NIC (15% on £23,500) | £3,525.00 |
Summary of Savings
| Saving | Amount per year |
|---|---|
| Employee NIC saving | £120.00 |
| Employer NIC saving | £225.00 |
| Total NIC saving | £345.00 |
Note that with salary sacrifice, the employee’s take-home pay is very similar, but £120 of NIC savings could be redirected into additional pension contributions. If the employer shares its £225 saving, the employee’s pension pot grows even further. Use our workplace pension calculator to model the exact savings for your situation.
Savings at Different Salary Levels and Contribution Rates
The following table shows the combined annual NIC savings (employer at 15% + employee at 8%) for various salary and contribution rate combinations, assuming all sacrificed amounts fall within the main NIC band. The employer saving is shown separately as many employers pass this on.
| Annual Salary | Sacrifice Rate | Amount Sacrificed | Employee NIC Saving (8%) | Employer NIC Saving (15%) | Total NIC Saving |
|---|---|---|---|---|---|
| £25,000 | 3% | £750 | £60 | £112.50 | £172.50 |
| £25,000 | 5% | £1,250 | £100 | £187.50 | £287.50 |
| £30,000 | 5% | £1,500 | £120 | £225 | £345 |
| £40,000 | 5% | £2,000 | £160 | £300 | £460 |
| £40,000 | 8% | £3,200 | £256 | £480 | £736 |
| £50,000 | 5% | £2,500 | £200 | £375 | £575 |
| £60,000 | 5% | £3,000 | £60 | £450 | £510 |
| £80,000 | 10% | £8,000 | £160 | £1,200 | £1,360 |
At higher salaries where some or all of the sacrificed amount falls above the upper earnings limit (£50,270), the employee NIC saving drops to 2% on that portion. However, the employer NIC saving remains at 15% regardless of the salary level, making salary sacrifice especially valuable from the employer’s perspective for higher earners.
Impact on Other Benefits and Entitlements
Because salary sacrifice reduces contractual gross pay, it can affect a range of other calculations and entitlements. Employers and employees should be aware of the following:
Mortgage Applications
Mortgage lenders typically assess affordability based on gross salary. A reduced contractual salary could lower the amount an employee can borrow. Some lenders will accept a letter from the employer confirming the pre-sacrifice salary, but not all. Employees who are planning to apply for a mortgage may wish to temporarily opt out of salary sacrifice, if the scheme allows it.
Statutory Payments
Statutory Maternity Pay (SMP), Statutory Paternity Pay (SPP), Statutory Sick Pay (SSP), and Shared Parental Pay are all calculated based on the employee’s reduced (post-sacrifice) earnings. This can result in lower statutory payments. Employers should consider whether to offer a “lifestyle event” opt-out that allows employees to revert to their original salary before these events.
Student Loan Repayments
Student loan repayments are calculated on gross pay after salary sacrifice. This means employees with student loans will repay slightly less each month, as their earnings for student loan purposes are lower. Whether this is beneficial depends on the individual’s loan balance and repayment timeline.
Life Insurance and Death-in-Service Benefits
If death-in-service or life insurance benefits are calculated as a multiple of salary, the reduced salary will produce a lower pay-out. Employers should consider basing these benefits on the pre-sacrifice “reference salary” instead.
National Minimum Wage Considerations
There is an important legal constraint on salary sacrifice: an employee’s post-sacrifice salary must not fall below the National Minimum Wage (NMW) or National Living Wage (NLW) for the hours they work. HMRC will treat any arrangement that brings pay below NMW as ineffective, and the employer could face penalties.
For 2026/27, the National Living Wage (for workers aged 21 and over) is £12.21 per hour. Employers must check that no employee’s post-sacrifice hourly rate drops below this threshold. This is particularly relevant for lower-paid workers or those with high contribution rates. In practice, many schemes set a floor so that employees earning close to NMW are automatically excluded or have their sacrifice rate capped.
Setting Up a Salary Sacrifice Pension Scheme
Implementing salary sacrifice requires careful planning and proper documentation. Here are the key steps:
- Consult your pension provider: Not all pension schemes support salary sacrifice. Check that your provider can accommodate the arrangement and understand any administrative requirements.
- Amend contracts of employment: A salary sacrifice arrangement requires a genuine contractual change. Each participating employee must agree in writing to reduce their salary. A simple exchange of letters or a signed agreement is sufficient.
- Communicate clearly: Employees need to understand the implications, including effects on statutory payments, mortgage applications, and other benefits. Provide worked examples and a clear FAQ document.
- Update payroll systems: Your payroll software needs to be configured to process the reduced salary and increased employer pension contributions correctly.
- Set review periods: Most schemes allow employees to opt in or out at set intervals (typically annually) or on the occurrence of a “lifestyle event” (marriage, birth of a child, partner losing their job, etc.).
- Consider auto-enrolment interactions: If you use salary sacrifice for auto-enrolment contributions, ensure you are still meeting your minimum contribution obligations based on the employee’s qualifying earnings.
Employer Obligations and Contractual Changes
HMRC requires that a salary sacrifice arrangement is a genuine, prospective change to the terms of employment. This means:
- The salary reduction must apply to future earnings, not retrospectively.
- The employee must have a genuine choice — it cannot be compulsory (although it can be the default option with an opt-out).
- The arrangement must be documented in writing, ideally as a variation to the employment contract.
- The employee’s reduced salary becomes their actual contractual salary for all purposes, including redundancy calculations, unless specified otherwise.
Employers must also be aware that HMRC can challenge salary sacrifice arrangements that it considers to be “sham” arrangements — for instance, if the employee can opt out at any time without restriction, or if the salary is not genuinely reduced for all purposes.
When Salary Sacrifice Is NOT Beneficial
Salary sacrifice is not always the right choice. Consider the following scenarios where it may be disadvantageous:
- Earnings near the National Minimum Wage: If an employee’s post-sacrifice pay would fall below NMW, the arrangement is not permitted. Even if it remains just above NMW, the reduced salary may cause financial hardship.
- Imminent mortgage application: The reduced contractual salary can limit borrowing capacity. Employees planning to buy a home in the near future may want to delay opting in.
- Expecting statutory payments: Employees who anticipate taking maternity, paternity, or extended sick leave should weigh the NIC saving against the reduction in statutory pay. The loss in SMP over 39 weeks can outweigh the annual NIC saving in some cases.
- Earnings below the primary threshold: Employees earning below the NIC primary threshold (£12,570 for 2026/27) are not paying NICs anyway, so there is no NIC saving from salary sacrifice. Tax relief via relief at source or net pay may be more straightforward.
- State pension and benefit entitlement: Although unlikely for most workers, if salary sacrifice reduces earnings below the lower earnings limit (£6,396 for 2026/27), the employee may not accrue a qualifying year for State Pension purposes.
- Complex administration for small employers: The contractual changes, payroll adjustments, and communication effort may not justify the savings for very small employers with only a handful of employees.
Making the Most of Salary Sacrifice
For the majority of employers and employees, salary sacrifice pensions represent a genuine win-win. Employers reduce their NIC bill and can use part of the saving to boost employee pensions, while employees benefit from lower tax and NIC on their contributions. The key is proper implementation: clear communication, robust contractual documentation, and awareness of the edge cases where salary sacrifice may not be appropriate.
To see exactly how much you and your employees could save with salary sacrifice, try our workplace pension calculator. It allows you to model different salary levels, contribution rates, and sacrifice arrangements to find the optimal setup for your workforce.