Salary sacrifice

Salary sacrifice is also called salary exchange’.

What is salary sacrifice?

Salary sacrifice, sometimes known as salary exchange, is an arrangement employers can make available to employees – the employee agrees to a reduction in their salary or bonus that is equal to their pension contribution.

In return, the employer will pay in the employee’s total pension contributions.

Employers can switch to salary sacrifice if they submit their contributions on a net (relief at source) or gross (net pay arrangement) basis. They’ll also not need to inform HM Revenue and Customs about switching their pension scheme to salary sacrifice.

What are the benefits?

In short, everyone pays out less tax.

As the employee is sacrificing part of their salary, both employer and employee pay less in National Insurance contributions (NIC). The employee will also pay less income tax.

There are several potential benefits to this:

  • Employees and employers can pay the tax savings into the employee’s pension pot – helping them save even more for the future.
  • Employees can increase their take-home pay.
  • Employers can offer an improved benefits package to their employees.
  • Employers can reinvest the money they’ve saved back into the business.

These savings in action

Employer savings

Figures in the below examples are based on an average salary of £25,000 per employee, with each sacrificing the legal minimum contribution of 5% on a qualifying earnings basis.

1 scheme member
Salary sacrificed by the employee:
£938		Employer NIC rate (2024/25):
13.8%		Employer’s yearly NIC savings:
£129.44
50 scheme members
Total salary sacrificed by all employees:
£46,900		Employer NIC rate (2024/25):
13.8%		Employer’s yearly NIC savings:
£6,472.20
500 scheme members
Total salary sacrificed by all employees:
£469,000		Employer NIC rate (2024/25):
13.8%		Employer’s yearly NIC savings:
£64,722.00

Employee savings

The below example assumes the employee earns £25,000 per year (that’s £2,083.33 per month), with the employer contributing 3% and the employee contributing 5% on a qualifying earnings basis.

Employer contribution per month:£46.90
Employee contribution per month:£78.17
The Income Tax reduction:£15.63
NIC reduction:£6.25

Net take home pay is only reduced by £56.28 and the employee will have £125.07 going into their pension pot each month.

information

This example of employee savings is correct as at 06/04/24.

Setting up salary sacrifice

Employers can offer salary sacrifice to all employees, as long it doesn’t reduce their salary to below minimum wage. From the 1 April 2024 this is £11.44 per hour for employees over the age of 23, known as the National Minimum Wage. Salary sacrifice can’t take earning below the lower earnings threshold.

Getting set up in just a few simple steps:

  1. Employers should get in contact with their payroll to see if they can facilitate salary sacrifice for the employer’s pension scheme.
  2. Employees will need to agree to the change in their contract or through an agreement letter. Employers will need employees’ permission before entering them into a salary sacrifice scheme. If they don’t agree to salary sacrifice, employers will need to take their employees’ pension contributions in the usual way.
  3. Employers will need to create a salary sacrifice worker group in their Online Services account. Make sure this is set up so that all contributions are paid by the employer and that the worker group is labelled accordingly eg ‘Salary sacrifice’. Please note, you’ll still need a standard worker group for those employees that don’t agree to pay in their pension contributions using salary sacrifice.
  4. Once the employer has received their employee’s permission and has their new worker group in place, they can set up the salary sacrifice scheme through their payroll. Before sending us any pension data over to us, make sure your worker groups match your payroll and, if submitting a data file, your worker IDs have been updated on the file.
Employers using salary sacrifice should take specialist employment advice on how best to vary the employment contract.

Unsure how to set up a salary sacrifice worker group? Download our step-by-step guide.

Make sure it’s right for you

Salary sacrifice won’t be for everyone, so there are a few things to consider before setting it up:

  • Employees may receive lower life cover as well as lower borrowing available on loans and mortgages. This is because of a lower take-home income. However, most providers will take salary sacrifice into consideration.
  • Employees’ entitlement to state benefits eg Statutory Maternity Pay and the State Pension may be affected if their salary falls below the level at which they pay National Insurance contributions.
  • If an employee opts out of a salary sacrifice arrangement, employers will need to make an adjustment to their refund to pay back the NIC (as the saving in NIC only applies if their money remains inside a pension).
  • Remember, employers won’t be able to offer salary sacrifice if it reduces employees’ salary to below the National Minimum Wage.

Salary sacrifice affects the employee’s terms and conditions of employment and is a matter of employment law, not tax or pensions law. 

More information on salary sacrifice/salary exchange: