Salary Sacrifice Pension Schemes

A guide to salary sacrifice pension arrangements – how they work, the benefits for employers and employees, and what to consider before implementing one.

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What is Salary Sacrifice?

Salary sacrifice (also called “salary exchange” or “smart pension”) is an arrangement where an employee gives up part of their contractual salary in return for a non-cash benefit – in this case, pension contributions.

How It Works

Without salary sacrifice:

1. Employer pays employee gross salary
2. Employee pays income tax and National Insurance on full salary
3. Employee contributes to pension from net pay
4. Tax relief added to pension contribution

With salary sacrifice:

1. Employee agrees to a lower contractual salary
2. Employer pays the “sacrificed” amount directly to the pension
3. Both employer and employee pay less National Insurance
4. Same total goes into the pension, but with NI savings

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The Benefits

For Employees

Benefit	Explanation
NI savings	Save 8-10% NI on the sacrificed amount
Higher pension contribution	Same cost, more in pension
Lower student loan repayments	(if applicable, as salary is lower)
Same take-home pay	Or slightly higher, depending on setup

Example: An employee earning £30,000 who contributes 5% (£1,500) via salary sacrifice instead of regular contributions saves approximately £120 per year in National Insurance – which can be added to their pension pot.

For Employers

Benefit	Explanation
NI savings	Save 13.8% employer NI on all sacrificed amounts
Enhanced benefit	Can pass NI savings to employees
Competitive advantage	More attractive pension scheme
Cost-neutral improvement	Better benefit at no extra cost

Example: An employer with 50 employees, average salary £35,000, with 5% salary sacrifice contributions:

• Annual NI saving: approximately £12,000
• This can fund enhanced benefits at no additional cost

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Employee Considerations

Salary sacrifice isn’t always beneficial for everyone. Employees should understand:

Potential Impacts

Area	Potential Impact
Mortgage applications	Lenders may use lower contractual salary
State benefits	Some means-tested benefits use gross salary
Life insurance	Death in service often based on salary
Statutory payments	SMP, SSP may be calculated on lower salary
Student loans	Repayments based on lower salary (benefit or issue depending on perspective)

Who Should Be Careful

• Those earning close to the National Minimum Wage (cannot sacrifice below NMW)
• Those planning major borrowing (mortgage, loans)
• Those claiming means-tested benefits
• Pregnant employees or those planning maternity leave

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Implementation Considerations

Legal Requirements

• Contractual change – Salary sacrifice requires a change to the employment contract
• Genuine choice – Employees must be able to opt out
• National Minimum Wage – Cannot reduce salary below NMW/NLW
• Clear communication – Employees must understand what they’re agreeing to

Payroll Changes

• Update salary records to reflect lower contractual salary
• Configure pension contributions as employer contributions
• Ensure correct tax and NI calculations
• Update any salary-linked benefits calculations

Communication

Employees need to understand:

• How the arrangement works
• The benefits (NI savings)
• The potential drawbacks (see above)
• Their right to opt out
• How to change their mind

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Our Salary Sacrifice Training Module

Our pension training platform includes a dedicated salary sacrifice module (6 minutes) that explains:

• What salary sacrifice means in plain English
• How it saves National Insurance for both employee and employer
• The impact on take-home pay vs pension pot
• Potential impacts on benefits and mortgage applications
• When salary sacrifice might not be right for you

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Salary Sacrifice vs Normal Pension

Aspect	Normal Pension	Salary Sacrifice
Employee NI	Paid on full salary	Paid on reduced salary
Employer NI	Paid on full salary	Paid on reduced salary
Take-home pay	After NI deduction	Similar or slightly higher
Pension contribution	Employee + tax relief	Employer (including savings)
Contractual salary	Unchanged	Reduced
Benefits linked to salary	Based on full salary	Based on reduced salary

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Common Questions

Is salary sacrifice tax avoidance?

No. Salary sacrifice is a legitimate, HMRC-approved arrangement. It’s not avoidance or a loophole – it’s simply a different way of structuring pension contributions that reflects the economic reality of the arrangement.

Can employees opt out later?

Yes. Employees can typically opt out of salary sacrifice (returning to normal pension contributions) at set review points – usually annually or at significant life events. The contract should specify this.

What about auto-enrolment?

Salary sacrifice schemes can be used for auto-enrolment, provided they meet the minimum contribution requirements. The employer contribution (including the salary sacrifice element) must meet or exceed the minimum employer contribution percentage.

Should we pass the NI savings to employees?

This is your choice. Options include:

• Pass all savings to employees’ pension pots
• Keep savings to offset administration costs
• Share savings between employer and employee
• Use savings to fund other benefits

Many employers pass at least some savings to employees as an enhanced benefit.

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Getting Started with Salary Sacrifice

If you’re considering implementing salary sacrifice:

1. Consult your pension provider – Confirm your scheme supports salary sacrifice
2. Get legal/payroll advice – Ensure correct contractual and payroll setup
3. Communicate clearly – Employees must understand the arrangement
4. Train employees – Ensure they understand benefits and considerations
5. Document everything – Keep records of employee choices

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Next Steps