Salary sacrifice & pension explained
How contributing to your pension via salary sacrifice reduces both your income tax and National Insurance — and why it is more tax-efficient than a standard employee contribution.
What is salary sacrifice?
Salary sacrifice (also called salary exchange) is an arrangement where you agree to give up part of your gross salary in exchange for a non-cash benefit — most commonly an employer pension contribution. Your contractual salary is formally reduced, and your employer pays the sacrificed amount directly into your pension pot.
Because your gross salary is lower, you pay less income tax and less National Insurance. This is the key advantage over a standard employee pension contribution, which is deducted after tax.
How the tax saving works
A standard pension contribution gives you income tax relief only — HMRC adds basic-rate tax relief to your contribution. A salary sacrifice contribution reduces your gross pay before tax and NI are calculated, saving both.
| Method | Saves income tax | Saves NI |
|---|---|---|
| Standard employee contribution | Yes (via tax relief) | No |
| Salary sacrifice | Yes | Yes |
Worked example: £42,000 salary, 5% sacrifice
| Without sacrifice | With sacrifice | |
| Gross salary | £42,000 | £39,900 |
| Income tax | £5,886 | £5,466 |
| National Insurance (8%) | £2,354 | £2,186 |
| Pension deducted from pay | £0 | £0 |
| Pension in pot (employer pays) | £0 | £2,100 |
| Net take-home | £33,760 | £32,248 |
| Tax + NI saved | — | £588/yr (£49/mo) |
The employee's take-home reduces by £1,512/year, but £2,100 goes into their pension — effectively getting £2,100 of pension for a net cost of £1,512.
The £100,000 trap — where sacrifice really pays off
If your income is between £100,000 and £125,140, your personal allowance is progressively withdrawn. This creates an effective marginal tax rate of 60% on that £25,140 band. Salary sacrifice pension contributions reduce your adjusted net income and can restore your personal allowance.
| Salary | £110,000 |
| Sacrifice needed to hit £100,000 | £10,000 |
| Income tax saved (at 60% effective rate) | £6,000 |
| NI saved (at 2% above UEL) | £200 |
| Total saving on £10,000 contribution | £6,200 |
Employer NI saving — the bonus most people miss
When you sacrifice salary, your employer also pays less National Insurance (13.8% on the sacrificed amount). Many employers pass this saving back to employees as an additional pension contribution. If your employer does this, it is worth asking about — on a £5,000 sacrifice, the employer saves £690 in NI.
Other common salary sacrifice schemes
Pension is the most popular, but salary sacrifice can apply to other benefits:
- Cycle to Work — bikes and equipment, typically up to £1,000 (or unlimited through some schemes)
- Electric vehicle lease — beneficial in kind tax rate for EVs is just 2% in 2026/27, making this very efficient
- Childcare vouchers — closed to new entrants, but existing members can continue
- Tech scheme — laptops, phones, etc.
Are there any downsides?
Salary sacrifice has a few things to be aware of:
- Your contractual salary is lower, which can affect mortgage affordability assessments, life assurance (if linked to salary), and statutory payments like maternity/paternity pay.
- If your salary would fall below the National Living Wage after sacrifice, the arrangement is not permitted.
- Some older defined benefit (final salary) pensions calculate benefits on your contractual salary — check before sacrificing.
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