Salary sacrifice is the most tax-efficient way for employees to contribute to a pension — and it saves the employer money at the same time
Under a salary sacrifice arrangement, an employee agrees to reduce their salary by the amount of their pension contribution. The employer then contributes that amount directly to the pension. Both parties pay less National Insurance as a result.
The mechanics — step by step
Employee agrees to reduce salary
The employee formally agrees to take a lower contractual salary. This requires a written agreement and an amendment to their employment contract.
Employer contributes the difference
The employer pays the sacrificed amount directly into the employee's pension scheme as an employer contribution, on top of any existing employer contribution.
Both pay less NI
The employee pays NI only on their reduced salary. The employer pays NI only on the reduced salary. Both save on Class 1 NI contributions.
Pension pot grows the same
The total going into the pension is unchanged — but both parties have paid less tax to achieve it. The employee's take-home pay is broadly the same as before.
A worked example
Employee salary: £42,000. Employee pension contribution: £2,100 (5% of salary).
Without salary sacrifice: Employee pays NI on £42,000. Employee pension contribution comes from post-tax, post-NI pay. Employer pays NI on £42,000.
With salary sacrifice: Employee salary reduces to £39,900. Employer contributes £2,100 to pension directly. Employee pays NI on £39,900 — saving approximately £252 per year. Employer pays NI on £39,900 — saving approximately £315 per year. The pension receives the same £2,100 in contributions. The employee's net pay is broadly unchanged or slightly higher due to the NI saving.
On a team of 50 employees at this average salary and contribution rate, the employer NI saving alone is approximately £15,750 per year.
What employers need to put in place
- Confirm that the existing pension scheme accepts salary sacrifice contributions — not all auto-enrolment schemes are set up for this
- Prepare a salary sacrifice agreement for each participating employee
- Amend employment contracts to reflect the new contractual salary
- Communicate the arrangement clearly to employees, including the edge cases where salary sacrifice may not be appropriate
- Update payroll to reflect the revised salary and contribution structure
- Notify the pension provider of the change in contribution classification
Aetas manages this process on behalf of employers as part of the Clarity pillar of the Workplace Performance Audit. Most implementations are completed within six to eight weeks of the decision to proceed.
Common questions
Can any employer implement salary sacrifice?
Most employers can implement salary sacrifice, provided their pension scheme accepts it and they are willing to make the necessary contract changes. There are some limitations: employees cannot sacrifice salary below the National Minimum Wage, and the arrangement must be genuine — HMRC is clear that a temporary arrangement designed purely for tax efficiency without a real salary change does not qualify.
Is salary sacrifice the same as the employer just paying more into the pension?
Not quite. In a standard additional employer contribution, the employer pays more from its own payroll cost. In salary sacrifice, the employee effectively redirects part of their own salary into the pension via the employer. The NI saving arises because the employee's taxable and NI-able salary is lower. The outcome for the pension pot can be similar, but the mechanics and the NI implications are different.
What happens if an employee wants to opt out?
Employees can typically opt out of a salary sacrifice arrangement, though this usually requires reverting to their original contractual salary and contribution structure. The process and timing for opting out should be set out clearly in the salary sacrifice agreement. An employee who opts out loses the NI saving but regains their higher contractual salary as the reference point for benefits calculations.
Does salary sacrifice affect auto-enrolment calculations?
Yes — and this is an important point. Auto-enrolment minimum contributions are calculated on qualifying earnings, which use the contractual salary after sacrifice as the reference figure. Employers need to ensure that minimum contribution requirements are still met after the sacrifice is applied. A regulated adviser should confirm the scheme remains compliant.
HMRC guidance on salary sacrifice for employers is at gov.uk. Auto-enrolment minimum contribution rules are published by The Pensions Regulator. National Minimum Wage rates are at gov.uk/national-minimum-wage-rates. This guide is for information only and does not constitute regulated financial or tax advice.
Find out if your pension scheme is set up for salary sacrifice
The Workplace Performance Audit includes a full pension and benefits review. Most employers find they are not capturing the full NI saving available to them.
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