Salary sacrifice — sometimes called "salary exchange" or "smart pay" — is an arrangement between you and your employer where you agree to give up part of your gross salary in return for a non-cash benefit, most commonly an increased employer pension contribution. Because the sacrificed amount never reaches you as salary, neither you nor your employer pay National Insurance on it, and you do not pay income tax on it either.
How Salary Sacrifice Works
Under a salary sacrifice arrangement, your contract of employment is formally varied to reduce your gross salary. Your employer then pays the sacrificed amount directly into your pension. Because this is an employer contribution (not an employee contribution), no income tax or employee National Insurance is due on it. Your employer also saves the employer National Insurance it would otherwise have paid on that portion of salary.
The key distinction from a normal pension contribution is that with salary sacrifice, the money never forms part of your pay — it goes straight from your employer into your pension. With a normal employee contribution, the money comes out of your net pay and the pension provider claims basic rate tax relief on your behalf.
Tax and NI Savings
The savings from salary sacrifice come from two sources: the employee saves National Insurance contributions on the sacrificed amount, and the employer saves employer National Insurance. Many employers pass some or all of their NI saving back to the employee as an additional pension contribution, making the arrangement even more attractive.
Worked Example: £50,000 Salary, £5,000 Pension Contribution
| Normal Contribution | Salary Sacrifice | |
|---|---|---|
| Gross salary | £50,000 | £45,000 |
| Employee pension contribution | £5,000 (from net pay) | £0 |
| Employer pension contribution | £0 | £5,000 |
| Employee NI saving | — | £1,000 (8% × £5,000 + 2% × remainder) |
| Employer NI saving | — | £690 (13.8% × £5,000) |
The employee saves approximately £1,000 in National Insurance contributions. The employer saves £690 in employer NI. Many employers add their NI saving to the employee's pension, meaning the total pension contribution could be £5,690. Income tax relief is identical in both cases. Figures are illustrative based on 2024/25 NI rates.
Impact on Mortgage Applications
One of the most important practical consequences of salary sacrifice is that it reduces your contractual gross salary. Mortgage lenders typically base affordability calculations on your gross salary. If your salary is £50,000 but you sacrifice £5,000, lenders may see your salary as £45,000. Some lenders will add back pension contributions when assessing affordability, but not all. If you are planning to apply for a mortgage, lenders can be asked how they treat salary sacrifice arrangements, and some mortgage applicants temporarily opt out of salary sacrifice before applying.
Impact on State Benefits
Several state benefits are calculated based on your actual (reduced) salary under a salary sacrifice arrangement:
- Statutory Maternity Pay (SMP): Based on your average earnings in weeks 17–25 of pregnancy. A lower salary means lower SMP.
- Statutory Sick Pay (SSP): Eligibility is based on your reduced earnings exceeding the lower earnings limit (£123 per week for 2024/25).
- Statutory Paternity Pay and Shared Parental Pay: Also based on reduced earnings.
If your reduced salary falls below the lower earnings limit, you could lose entitlement to these benefits altogether. Employers are legally required to ensure salary sacrifice does not reduce your pay below the National Minimum Wage or National Living Wage.
Impact on Student Loan Repayments
Student loan repayments are calculated on your actual earnings after salary sacrifice. This means salary sacrifice effectively reduces your student loan repayments, since they are based on earnings above the relevant threshold. For Plan 2 loans (post-2012), repayments are 9% of earnings above £27,295. A £5,000 salary sacrifice would reduce annual student loan repayments by approximately £450. Whether this is beneficial depends on your circumstances — lower repayments mean it takes longer to repay, and if you are unlikely to repay the full balance before it is written off after 30 years, the lower repayments are simply a cash flow benefit.
Salary Sacrifice for Other Benefits
Pensions are the most common salary sacrifice benefit, but the same mechanism can be used for several other HMRC-approved benefits:
- Cycle to Work: Save tax and NI on a bicycle and cycling equipment (up to £1,000 or more with employer agreement).
- Electric cars: Ultra-low emission vehicles via salary sacrifice attract a very low benefit-in-kind rate (2% for 2024/25), making electric car salary sacrifice schemes extremely tax-efficient.
- Workplace nursery schemes: Childcare provided directly by or on behalf of the employer through a qualifying workplace nursery is exempt from tax and NI.
Since April 2017, most other benefits (such as mobile phones, gym memberships) no longer qualify for tax-efficient salary sacrifice. Only pensions, childcare, cycle to work, and ultra-low emission cars retain the full tax and NI advantages.
Who Benefits Most
- Higher rate taxpayers: Save 40% income tax plus NI on sacrificed amounts — the NI saving is the bonus on top of what they would already save through a normal pension contribution.
- Those caught in the 60% tax trap: Earners between £100,000 and £125,140 lose their personal allowance at a rate of £1 for every £2 of income above £100,000. Salary sacrifice can bring adjusted net income below £100,000, restoring the full personal allowance. See our 60% tax trap guide for more details.
- Those with employer NI pass-back: Where employers add their NI saving to the employee's pension, the total benefit is even greater.
Who Should Be Cautious
- Those near the National Minimum Wage: Your employer cannot reduce your salary below the NMW/NLW through salary sacrifice. If you are close to the threshold, the amount you can sacrifice may be limited.
- Those relying on state benefits: If you are claiming or may need to claim benefits based on your earnings (maternity pay, sick pay), salary sacrifice will reduce those entitlements.
- Those applying for a mortgage: A reduced gross salary may affect how much you can borrow. Consider the timing carefully.
- Those with death-in-service benefits: Some employer death-in-service policies pay a multiple of salary. If your contractual salary is reduced, the payout may be lower. Check with your employer.
For more on pension tax relief and contribution limits, see our self-employed pension guide and retirement planning guide.
This guide is for general information only and does not constitute financial advice. The information is based on publicly available data from HMRC and other government sources. Always seek professional advice before making financial decisions. Figures and thresholds are subject to change — check official sources for the latest values.