Salary Sacrifice for Pensions: How to Save More Tax and National Insurance

When my employer first mentioned salary sacrifice for pensions, I did not pay much attention. It sounded like accountancy jargon. But when I actually understood how it worked, I realised it could save me hundreds of pounds a year in tax and National Insurance. Here is how it works.

What Is Salary Sacrifice?

Salary sacrifice (sometimes called salary exchange) is an arrangement where you agree to give up part of your gross salary in exchange for your employer making an equivalent pension contribution. Instead of receiving the money as salary and then contributing it to your pension after tax and National Insurance, the money goes directly into your pension before either is deducted.

The key difference from normal pension contributions is the National Insurance saving. With a standard pension contribution, you get income tax relief but you still pay National Insurance. With salary sacrifice, you save on both.

The Numbers

Let me illustrate with an example. Say you earn £50,000 and want to put £500 per month into your pension.

With a standard pension contribution, you pay £500 from your net salary. Your pension provider claims 20% tax relief, so £625 goes into your pension. But you have already paid National Insurance (8%) on the £500, costing you £40. Total cost to you: £500. Total in pension: £625.

With salary sacrifice, your salary drops by £625 (the gross amount). That £625 goes straight into your pension as an employer contribution. You save income tax (£125) and also save employee National Insurance (£50 on £625). Total cost to you: £375 in reduced take-home pay. Total in pension: £625.

The result is the same £625 in your pension, but salary sacrifice costs you £125 less per month because of the NI saving. Over a year, that is £1,500. Over 20 years, invested at 5% growth, that additional saving could grow to over £50,000.

Employer Benefits

It is not just you who saves. Your employer also saves on their National Insurance contributions (currently 13.8% on earnings above the secondary threshold). Many employers pass some or all of this saving back to you as an additional pension contribution, making the deal even better.

Always ask whether your employer passes on their NI saving. Some add it automatically, others do it if you ask, and some keep it. It is worth raising.

Things to Watch Out For

Salary sacrifice reduces your official salary. This can affect other things linked to your salary level:

Mortgage applications may be based on your reduced salary, which could affect how much you can borrow. However, most lenders now understand salary sacrifice and will consider your pre-sacrifice salary. Statutory benefits like maternity pay, sick pay, and redundancy pay are calculated on your actual salary after sacrifice. If your salary after sacrifice falls below certain thresholds, you might lose some benefits. Most employers set a floor to prevent your salary from dropping below the National Minimum Wage.

Income tax thresholds are also based on your reduced salary, which is actually an advantage. If sacrifice brings you below £50,270, you stay in the basic rate band. If it brings you below £100,000, you keep your full personal allowance.

Who Benefits Most?

Salary sacrifice is beneficial for almost everyone, but the savings are most significant for higher rate taxpayers and those with earnings near the £50,270 or £100,000 thresholds. For basic rate taxpayers, the saving is primarily the employee NI.

If your employer offers salary sacrifice, I would generally recommend using it. The NI saving is essentially free money that would otherwise go to HMRC.

How Does This Relate to SIPPs?

Salary sacrifice applies to your workplace pension, not to a SIPP. You cannot salary sacrifice into a SIPP because your employer needs to be involved in the arrangement.

The ideal strategy for many people is to use salary sacrifice for their workplace pension (to get the NI saving and employer match) and then make any additional contributions into a SIPP where they have full control over investment choice. This gives you the best of both worlds.

Use our [SIPP calculator](/) to model your overall pension contributions and projected retirement pot.