Salary sacrifice – sometimes called salary exchange – is an arrangement where you agree to reduce your contractual salary in return for an equivalent employer pension contribution. Rather than taking that portion of your pay as cash (which would be taxed and subject to National Insurance), it goes straight into your workplace pension as an employer contribution.
The beauty of this setup is that neither you nor your employer pay National Insurance on the sacrificed amount, and you don’t pay Income Tax on it either. It’s a genuine tax efficiency, not a loophole. Salary sacrifice is available to employees paid through PAYE, which means it’s relevant whether you’re running a small limited company and paying yourself a salary, or you employ a team and want to offer them a valuable benefit.
The arrangement requires a formal change to your employment contract – even if it’s just a simple variation letter – because you’re agreeing to a lower gross salary going forward. That reduced salary is what HMRC, lenders, and benefits agencies see, so it’s important to understand both the savings and the knock-on effects before you commit.
How salary sacrifice works step by step
The mechanics are straightforward once you understand the flow. You and your employer agree to reduce your contractual gross salary by a specific amount each pay period – say, £200 per month. That £200 never appears as taxable pay on your payslip. Instead, your employer makes an additional pension contribution of £200 on your behalf.
From a payroll perspective, your gross pay is lower from the outset, so Income Tax and National Insurance are calculated on the reduced figure. The pension contribution shows up separately, usually labelled as an employer contribution rather than an employee deduction. Your take-home pay will typically be higher than it would have been if you’d made the same contribution from your net pay, because you’ve saved both employee National Insurance (at 8% for most people, 2% above the upper earnings limit) and Income Tax at your marginal rate (20%, 40%, or 45%).
Your employer also saves on their National Insurance – currently 13.8% on earnings above the secondary threshold – which is why many firms are happy to implement salary sacrifice schemes and sometimes even share part of that saving with employees by boosting the pension contribution further.
What changes on your payslip
Before salary sacrifice, your payslip might show a gross salary of £3,000, with a pension deduction of £240 (8% employee contribution), leaving taxable pay of £2,760. After tax, NI, and other deductions, you’d take home a certain amount.
With salary sacrifice in place, your gross pay drops to £2,760 straight away. There’s no employee pension deduction line, because you’re not contributing from your net pay – the £240 is being made by your employer and appears in the employer contributions section. Your taxable pay is now £2,760, so you pay less tax and less NI. The net result? More money in your pocket each month, and the same (or often more) going into your pension.
Eligibility: who can and can’t use salary sacrifice
Salary sacrifice is only available to employees who are paid through PAYE. If you’re genuinely self-employed – filing a self-assessment return as a sole trader, for instance – you can’t use salary sacrifice because there’s no employer to vary your contract. You can still make personal pension contributions and claim tax relief, but the mechanism is different.
Who can typically use salary sacrifice:
- Company directors paid via PAYE
- Full-time and part-time employees on permanent contracts
- Some fixed-term contract workers (subject to employer policy)
- Agency workers through umbrella companies (if the umbrella offers it)
Who usually can’t:
- Sole traders and genuinely self-employed individuals
- Those earning at or near National Minimum/Living Wage
- Employees whose contracts explicitly prohibit it
Many employers impose their own rules – probation periods, minimum service requirements, or restrictions on how often you can change your sacrifice amount. Check your scheme documents before assuming you’re eligible.
National Minimum Wage and Living Wage safeguards
⚠️ Critical compliance point: Your salary sacrifice cannot reduce your cash pay below the National Minimum Wage or National Living Wage for your age and employment status. HMRC and employment tribunals take this seriously, and breaches can lead to penalties and back-pay liabilities.
Your employer must check that your post-sacrifice salary, divided by your contractual hours, stays above the relevant NMW/NLW threshold. If you’re a lower earner or work part-time, salary sacrifice may not be viable at all. Employers typically run automated checks at enrolment and again whenever thresholds change (usually each April).
Benefits and savings you can expect
The appeal of salary sacrifice is the tangible, immediate saving on tax and National Insurance. For an employee, the combination of avoiding employee NI (typically 8% or 12%, depending on your earnings) and Income Tax at your marginal rate can make a significant difference to your monthly cashflow while building your pension pot faster.
How much can you actually save?
Tax BandIncome Tax RateEmployee NICombined Saving on £100 SacrificedBasic rate (£12,571–£50,270)20%8%£28Higher rate (£50,271–£125,140)40%8%*£48Additional rate (£125,140+)45%2%**£47
*Assuming earnings below upper earnings limit; **2% NI applies above ~£50,270
Let’s say you’re a basic-rate taxpayer earning £35,000 and you decide to sacrifice £100 per month. Without salary sacrifice, you’d need to earn roughly £140 gross to have £100 left after tax (20%) and NI (8%) to contribute. With salary sacrifice, that £100 goes straight into your pension, and your take-home pay only drops by £72 – you’ve saved £28 in tax and NI.
Before committing to any specific amount, it’s worth using a salary sacrifice pension calculator to model exactly how the numbers work for your salary, tax band, and contribution level. These calculators show you side-by-side comparisons of take-home pay with and without sacrifice, making it much easier to see whether the arrangement fits your budget.
Employer National Insurance savings and sharing arrangements
Every pound you sacrifice saves your employer 13.8p in employer NI (assuming you’re above the secondary threshold, which most full-time employees are). On an annual sacrifice of £1,200, that’s £165.60 back in the employer’s pocket.
Many employers choose to share some or all of this saving with employees by adding it to the pension contribution. If your employer offers a 50% share, your £100 sacrifice becomes a £106.90 contribution (£100 from you, £6.90 from the employer NI saving). Some employers pass on the full 13.8%, making it £113.80. Either way, it’s free money that wouldn’t exist without salary sacrifice.
For small business owners, managing payroll efficiently whilst staying compliant can be time-consuming. Modern business banking platforms streamline these administrative tasks, allowing you to focus on strategic decisions about employee benefits like salary sacrifice rather than getting bogged down in paperwork.
Impact on adjusted net income and allowances
Salary sacrifice reduces your taxable income, which in turn lowers your “adjusted net income” for tax purposes. This matters if you’re caught by one of the UK’s various tapers and cliffs:
- High Income Child Benefit Charge: If you or your partner claim Child Benefit and your adjusted net income is between £60,000 and £80,000, you face a gradual clawback via a tax charge. Salary sacrifice can pull you below the threshold or reduce the charge.
- Personal allowance taper: Earn over £100,000 and your personal allowance is reduced by £1 for every £2 over. Salary sacrifice can help you keep more of your allowance.
- Student loan repayments: Because salary sacrifice reduces your gross pay, it also lowers your monthly student loan repayments (typically 9% of earnings above a threshold). That’s money staying in your pocket today, though your loan balance will take slightly longer to clear.
Potential downsides and risks
Salary sacrifice isn’t universally beneficial. The same mechanism that delivers tax savings – reducing your contractual gross salary – can create complications in other areas of your financial life.
Key risks to consider:
Statutory payments: Maternity, paternity, adoption, and sick pay are calculated on your average weekly earnings. If you’ve been sacrificing salary, these payments will be lower – potentially by hundreds of pounds over a leave period.
State Pension qualifying years: You need 35 qualifying years of NI contributions for the full State Pension. Salary sacrifice reduces your NIable earnings, so if you’re close to the Lower Earnings Limit (£6,396 for 2024/25), you could lose a qualifying year.
Salary-linked benefits: Death-in-service cover, income protection, redundancy pay, and bonus calculations may be based on your reduced post-sacrifice salary unless your employer uses a “reference salary” arrangement.
Mortgage affordability: Lenders assess you on contractual income. A lower gross salary on paper can reduce borrowing capacity. Some lenders accept evidence of pre-sacrifice salary, but not all.
Cashflow constraints: If you’re earning close to NLW or have variable income, salary sacrifice may be impractical. Even stable earners need to ensure they can afford lower monthly take-home pay.
Who should consider salary sacrifice – and who shouldn’tSituations where salary sacrifice is often worth it
You’re likely to benefit if you have stable income well above NLW, your employer shares NI savings, you’re a higher or additional-rate taxpayer, you’re affected by the Child Benefit Charge or personal allowance taper, you have no immediate mortgage plans, and you have a long time horizon until retirement.
When salary sacrifice may not be the best choice
Think twice if your income is variable or close to NMW/NLW, you’re applying for a mortgage soon, you’re likely to take parental leave in the near future, you rely heavily on salary-linked benefits without reference salary protection, you have high-interest debt or no emergency fund, or you have a short time horizon before accessing your pension.
Pension limits and key interactionsAnnual Allowance and contributions
The standard Annual Allowance for pension contributions is currently £60,000 per tax year. Crucially, sacrificed amounts count as employer contributions, so they use up your Annual Allowance just like regular employer contributions.
If your income exceeds certain thresholds (£200,000 threshold income, £260,000 adjusted income), your Annual Allowance is tapered down to a minimum of £10,000. Salary sacrifice can help by reducing your threshold income.
If you’ve accessed your pension flexibly – taking drawdown or certain lump sums – you trigger the Money Purchase Annual Allowance (MPAA), currently £10,000 per year, which severely limits future contributions including salary sacrifice.
Alternatives to salary sacrifice
If salary sacrifice doesn’t suit your circumstances, you can make contributions to a personal pension or SIPP from your net income. Basic-rate taxpayers get 20% relief automatically; higher and additional-rate taxpayers claim extra relief through self-assessment. You miss out on the NI saving, but you gain full control over provider and investments.
Some employers allow you to sacrifice annual bonuses or commission, even if regular salary sacrifice isn’t offered. This can deliver significant tax savings on lump sums that would otherwise be taxed at your marginal rate.
Before maximising salary sacrifice, ensure you’re capturing any employer matching contributions first – that’s free money. Also weigh pension contributions against other priorities like clearing high-interest debt or building an emergency fund.
Tools and resources to get startedUsing a salary sacrifice calculator
A calculator lets you model the impact on take-home pay, tax and NI savings, and pension contributions. You’ll input your current salary, proposed sacrifice amount, tax year, location (rates differ in Scotland), and whether your employer shares NI savings. The side-by-side comparison makes it easy to see whether the trade-off works for your budget.
Questions to ask HR or payroll
Before committing, clarify:
- Does the scheme use a reference salary for benefits, or are they based on post-sacrifice pay?
- Will you share employer NI savings, and if so, what percentage?
- How are statutory payments calculated if I’m sacrificing?
- What are the minimum and maximum amounts, and can I change them during the year?
- How does the scheme handle long-term sickness or unpaid leave?
- What documentation will I receive?
Pre-enrolment checklist
Before opting in:
- ✓ Confirm sacrifice won’t take you below NMW/NLW
- ✓ Check you can afford the reduction in take-home pay
- ✓ Understand how statutory pay and State Pension years are affected
- ✓ Verify you’re not applying for a mortgage imminently
- ✓ Ask about NI sharing and reference salary policies
- ✓ Model the numbers using a calculator
FAQsCan company directors use salary sacrifice if they’re paid via PAYE?
Yes. As long as you’re employed by your company and paid through PAYE, you can set up salary sacrifice like any other employee. Just ensure you don’t drop below the NI lower earnings limit if you want to maintain State Pension qualifying years, or below any minimum salary required by lenders.
Will I need to file a self-assessment tax return if I use salary sacrifice?
Not solely because of salary sacrifice – it delivers tax relief automatically via payroll. However, you may still need to file if you have other income, you’re claiming relief on separate personal pension contributions, you’ve exceeded the Annual Allowance, or other circumstances trigger self-assessment.
How is salary sacrifice reflected on my P60 and P11D?
Your P60 will show your gross pay after salary sacrifice – your reduced contractual salary. Employer pension contributions don’t appear on your P11D, as they’re not a benefit in kind for tax purposes. Your pension provider will send you a separate annual statement showing total contributions.
What happens during unpaid leave or zero pay periods?
If you’re on unpaid leave and receiving no pay, there’s nothing to sacrifice, so your arrangement effectively pauses. When you return, it typically resumes automatically unless you’ve opted out. During paid leave (statutory maternity pay, sick pay), your sacrifice usually continues based on the reduced pay you’re receiving.
Can I use salary sacrifice if I’m on a fixed-term or temporary contract?
Yes, if your employer offers it and you’re paid through PAYE. However, some employers require minimum service periods before you’re eligible. If your contract is very short (a few months), the administrative effort may outweigh the modest tax saving. Check with HR about eligibility and notice periods.
Final thought: Salary sacrifice is one of the most tax-efficient ways to build your pension in the UK, but it’s not automatic. The value depends on your circumstances, your employer’s policies, and your financial goals. Take time to model the numbers, ask the right questions, and ensure it fits with the rest of your plan. Done well, it can save you thousands in tax and NI over your career – money that compounds in your pension and gives you a more comfortable retirement.
