Salary Sacrifice Pension | December 2023

A salary sacrifice pension, also known as salary exchange, is an arrangement where an employee agrees to forfeit part of their gross salary. 

This is in return for their employer paying the sacrificed amount directly into their pension, working to boost pension contributions in a tax-efficient way.

This method is an advantageous way of boosting your pension contributions, whilst also reaping benefits from less national insurance and income tax.

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Understanding Salary Sacrifice Pensions

With a salary sacrifice pension, the employee’s gross pay is reduced by an agreed amount. Then, The employer contributes this sacrificed sum directly into the employee’s workplace pension scheme. 

This has the potential to result in substantial national insurance savings, for both you and the employer. 

Your employee contract will outline the salary reductions for you, making it a legal agreement between you and your employer. 

The salary sacrifice scheme is a flexible arrangement, allowing you to agree on the amount that would be sacrificed. This could be a percentage of your salary or a fixed amount.

Not everyone finds salary sacrifice pensions the best option for them, especially those earning around the national minimum wage. The sacrifice could potentially reduce their pay below the legal minimum. 

If you are wondering “how does salary sacrifice pension work?” or if you are unsure if it’s the best decision for you,  it’s important to consult with a financial adviser or use a salary sacrifice calculator to understand the implications fully. 

This will allow you to organise your finances accordingly. 

This arrangement could also have an impact on your earning related benefits. Given that your salary falls, the earnings related payments, such as statutory maternity pay, may also reduce accordingly. 

However, these potential impacts can be reduced through a notional salary arrangement. This is when pay rises and benefits are based on the pre-sacrifice salary.

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How Does A Salary Sacrifice Pension Work

A way of understanding how a salary sacrifice pension works is to consider an employee earning an average salary. 

That employee agrees to a lower salary, sacrificing a pre-agreed part of their salary. Rather than this reduction being a loss for the employee, it is a smart salary sacrifice redirected into their pension fund for retirement. 

The employer must contribute the sacrificed amount to the employee’s pension scheme. 

This is then added to the employer contribution that is already being made towards the employee’s pension. As a result, the pension contributions increase, boosting the employee’s pension pot.

Whilst this arrangement will reduce the employee’s take-home pay, it is considered a strategic move to plan for future savings. 

The reduced monthly pay means less income tax and national insurance contributions. Therefore, this produces a national insurance saving for both the employer and the employee. 

However, it’s vital that the employers receive their employees permission before making changes such as these to their contract. It’s worth noting that this arrangement might not be suitable for self-employed people, requiring an employer to make contributions.

Benefits of Salary Sacrifice Pensions

One of the most appealing aspects of the salary sacrifice pension scheme is that you may pay less income tax and national insurance

This is because the sacrificed contribution comes out of your gross pay, reducing your taxable income. This means you pay less income tax and both you and your employer pay less in national insurance contributions.

Another beneficial aspect is that it allows for a larger pension pot. The money that you’ve sacrificed goes straight into your pension fund, boosting your total pension contributions. 

Over time, this can substantially increase the size of your pension pot, ensuring a healthier financial situation when you reach retirement.

This particular pension scheme can also lead to enhanced contributions from employers. Often employers will choose to pass on a portion or all the money which they save from lower national insurance contributions to the employee’s pension fund. 

This means that you could potentially receive more than just your sacrificed salary into your pension.

The final notable attraction is that a salary sacrifice pension scheme can offer tax savings. For example, the sacrificed part of your salary is exempt from tax, making it a tax-efficient way to save for your retirement. 

However, it’s important to remember that tax rules can change and that the benefits depend on individual circumstances.

Alternatively, it is important that employees ensure they are not losing out on any workplace benefits, including life insurance cover, as a result of the salary sacrifice. To maintain the same level of cover, some employers may adjust these benefits.

Understanding Salary Sacrifice Pensions

How to Implement Salary Sacrifice Pensions

The first step in implementing a salary sacrifice pension is to form an agreement between the employer and the employee.

The employee will agree to give up a portion of their salary, and in return, the employer contributes that amount to the employee’s pension scheme. 

This agreement is typically formalised in an agreement letter, and is treated as a change to the terms and conditions of the employee’s contract.

However, not all employers offer salary sacrifice pensions. If your employer offers this scheme, they will provide you with the necessary information and facilitate salary sacrifice. 

They will also adjust your pay and contributions accordingly and participate in employer contributions. 

The sacrificed amount is then paid directly into the employee’s pension scheme by the employer during each pay period. This amount is added to any standard pension contributions that the employer makes. 

Although the employee’s net monthly income will decrease, their overall future pension savings will grow. This is due to the increased employer contributions. 

Employees should know that they have the right to opt out of the salary sacrifice scheme, usually by notifying their employer. Conversely, the ability to opt back in may be restricted to certain times in the tax year or require the employer’s agreement.

"A salary sacrifice pension, also known as salary exchange, is an arrangement where an employee agrees to forfeit part of their gross salary."

Potential Downsides of Salary Sacrifice Pensions

Whilst a salary sacrifice scheme has its advantages, there are also some potential downsides which should be considered. One of the main concerns, as mentioned previously,  is that it could reduce your salary to a level below the national minimum wage. 

This is illegal, and employers must ensure that the salary after sacrifice does not fall below this level. 

Earnings related benefits can also be impacted. Therefore, as your salary decreases, so does the amount you receive in benefits. 

Examples of these benefits include statutory maternity pay or contribution-based benefits. It might also affect your entitlement to state benefits.

Unfortunately, your ability to borrow money may also be impacted. It may affect the amount you can borrow for a mortgage or loan as these are often based on your salary, which will be decreased. 

According to MoneyHelper, most mortgage lenders are willing to base their lending decision on your pre-sacrifice income. On the other hand, it may be necessary to provide proof of your original salary.

However, your employer may be able to provide you with a letter to confirm what your pre-sacrifice salary was, and your mortgage can be based on this amount.

Furthermore, remember that entering into a salary sacrifice lowers your gross pay. This means that you should consolidate the potential impact on your future entitlement to means-tested state benefits.

The final drawback is that if your employer decides to opt out of the scheme, you would lose the additional pension contributions and tax savings that you have been building up.

How Does A Salary Sacrifice Pension Work

Salary Sacrifice Pensions and Tax Implications

The salary sacrifice pensions scheme is considered a tax-efficient way of saving for retirement. The sacrificed part of the salary is not subjected to income tax or national insurance contributions. 

These tax savings allow a greater proportion of your gross pay to be contributed to your pensions.

However, you should note that salary sacrifice could potentially affect your entitlement to state benefits, including the state pension. When your earnings related contributions are reduced, it could further impact the amount you receive from the state pension. 

Also, the income tax band that you fall into might be affected due to the sacrificed salary. If the sacrifice brings your salary into a lower tax band, you could potentially pay less income tax. 

Alternatively, if your salary falls too much, it could affect your ability to contribute to your pension. 

It is necessary that salary sacrifice schemes comply with employment law and auto enrolment rules. For instance, employers must ensure the employee’s salary after the sacrifice is above the legal minimum contribution.

As tax implications can be complex and rules are often changing, support from a financial adviser is recommended before entering into a salary sacrifice arrangement.

This will ensure that you understand the full implications and how it could affect your financial situation.

Non-Cash Benefits and Contributions

Salary Sacrifice pensions can also offer non-cash benefits, such as life cover. This provides an additional layer of financial security to the employees.

Salary sacrifice contributions can also be used to offer benefits, such as childcare vouchers or additional annual leave. These benefits will often improve employees’ work-life balance and overall satisfaction. 

However, remember that it is up to each employer to decide on the type of non-cash benefits they may wish to offer. 

As we now know, the employee pension contributions are made pre-tax, meaning it’s a tax-efficient way to save. This is because the employees pay tax on their reduced salary, leading to tax savings. 

However, the tax implications can be complex, and it’s advisable to seek professional advice.

On the other hand, it is vital to consider that contribution-based benefits, like the state pension, could be affected by a salary sacrifice scheme. 

Furthermore, since the employee’s earnings are reduced, it could impact the amount they receive from contribution-based benefits.

Contribution-Based Benefits and Salary Sacrifice

The decision to join a simple salary sacrifice scheme could have an impact on contribution-based benefits. Since the employee’s earnings are reduced, it could affect the amount they receive from benefits like the state pension or statutory maternity pay. 

To avoid this, some employers may offer a notional salary arrangement where contribution-based benefits are calculated on pre-sacrifice pay. 

Therefore, the risk of these benefits being reduced is reduced. This ensures that the employee doesn’t lose out on these benefits and can have an optimised pension contribution. 

It should be noted that the sacrificed salary is exempt from income tax and national insurance contributions. 

Remember that tax rules can change, and the benefits of a salary sacrifice scheme depend on the individual circumstances. But generally, this creates an efficient way of saving. 

The sacrificed part of the salary goes directly into the employee’s pension fund, boosting the employee’s total pension contributions. This can be a notable advantage for employees looking to save for their retirement in a tax-efficient way.

People Who Should Consider Salary Sacrifice Pensions

To higher earners paying tax at 40% or more, salary sacrifice pensions are a suitable option. Alternatively, the tax savings for basic 20% rate taxpayers are less significant. 

Furthermore, lower earners may find the take-home pay impact too great, meaning that the suitability is dependent on your individual financial circumstances.


1. How does a pension salary sacrifice work?

A pension salary sacrifice works by reducing an employee’s pre-tax salary. The employee will need to agree to this reduction, and then the employer contributes the sacrificed amount directly into the employee’s pension scheme. 

This generates contributions to the pension fund by reducing take-home pay. However, the lower take-home pay also means the employee might pay less in income tax and national insurance.

Not all employers offer pension salary sacrifice schemes, and not all employees may find it beneficial. For instance, self-employed people may not have an employer to make contributions on their behalf, making this scheme unsuitable for them.

2. What are some of the non-cash benefits of a salary sacrifice pension scheme?

The salary sacrifice scheme is not just about employees’ pension contributions, with the salary sacrificed by the employee potentially being used to offer non-cash benefits. 

For example, life cover, childcare vouchers or additional annual leave. It is important to note that the exact benefits offered can vary depending on the employer. 

These non-cash benefits aim to improve an employee’s work-life balance and overall job satisfaction. 

Furthermore, they’re also exempt from income tax and national insurance contributions, just like the salary sacrificed, making them another tax-efficient aspect of the scheme.

How to Implement Salary Sacrifice Pensions

3. How do employee contributions change under a salary sacrifice pension scheme?

The amount of salary sacrificed by the employee is paid directly into their pension scheme by their employer. This increases the total contributions made to the pension scheme, helping to build a larger pension pot for the employee’s retirement.

However, the increase in pension contributions also means a decrease in the employee’s monthly pay. This is something employees need to consider before deciding to enter into a salary sacrifice pension scheme.

4. Is a salary sacrifice pension scheme a tax-efficient way to save for retirement?

Yes, a salary sacrifice pension scheme is considered to be a very tax-efficient way to save for retirement. This is because the salary that the employee agrees to sacrifice is taken from their pre-tax salary. Therefore, this is not subject to income tax or national insurance contributions. 

As a result, whilst the employee pays less tax and national insurance on their take-home pay, the employer pays decreased national insurance contributions. This tax efficiency is one of the main reasons why salary sacrifice pension schemes are popular.

5. How does a salary sacrifice pension scheme affect contribution-based benefits?

It is important to consider that a salary sacrifice pension scheme can have an impact on contribution-based benefits. As the employee’s pre-tax salary is reduced, the amount which they receive from benefits like the state pension or statutory maternity pay could be affected.

Notional salary arrangements are sometimes offered by employers to attempt to mitigate these potential impacts. Under this arrangement, contribution-based benefits are calculated based on the pre-sacrifice salary. 

This guarantees that the employee doesn’t lose out on these benefits, despite participating in a salary sacrifice scheme.

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