Pension Types
Official Definition
According to HMRC, there are three main ways pension contributions receive tax relief: Salary Sacrifice (also called Salary Exchange), Relief at Source, and Net Pay Arrangement.
What They Are (Plain English)
Think of pension types as three different routes to the same destination - getting tax relief on your retirement savings. The key difference is when you get that relief and how it's applied. Your employer's pension scheme will use one of these methods, and understanding which one matters because it affects your tax code, your payslip, and sometimes how much you can contribute.
- Salary Sacrifice: Deducted before tax and NI - you save the most
- Relief at Source: You pay after tax, provider claims 20% back from HMRC
- Net Pay: Deducted before income tax, after National Insurance
The Three Types Explained
1. Salary Sacrifice (Most Tax-Efficient)
With salary sacrifice, you agree to receive less salary in exchange for your employer paying the difference into your pension. Because your salary is lower, you pay less tax and less National Insurance. Your employer saves on their NI too, and many pass these savings back to you as extra pension contributions.
How it feels on your payslip: Your gross salary is already reduced - you never "see" the pension money as salary.
You earn £40,000 but sacrifice £4,000 to pension.
Your payslip shows:
- Gross salary: £36,000 (not £40,000)
- You pay tax and NI on £36,000
- Pension pot: £4,000 goes in
2. Relief at Source (Simplest for You)
You contribute from your take-home pay (after tax), and your pension provider automatically claims back 20% basic-rate tax from HMRC and adds it to your pot. If you're a higher or additional-rate taxpayer, you can claim the extra relief through Self Assessment or by updating your tax code.
How it feels on your payslip: Your gross salary is unchanged. The money comes out of your bank account after payday.
You want £100 in your pension. You pay £80, your provider claims £20 from HMRC.
If you're a higher-rate (40%) taxpayer:
- You pay £80 from your bank
- Provider claims £20 from HMRC → £100 in pot
- You claim extra £20 back via tax return (40% - 20% = 20%)
- Net cost to you: £60
3. Net Pay (Less Common)
Your employer deducts the pension before calculating income tax, but after National Insurance. You get immediate income tax relief but still pay NI on the full amount. This method doesn't work well if you earn below the personal allowance.
How it feels on your payslip: Shows full gross salary, then pension comes off before tax.
You earn £40,000 and contribute £4,000.
Your payslip shows:
- Gross salary: £40,000
- National Insurance: calculated on £40,000
- Pension deduction: £4,000
- Income tax: calculated on £36,000
Side-by-Side Comparison
| Feature | Salary Sacrifice | Relief at Source | Net Pay |
|---|---|---|---|
| Tax relief | Automatic (immediate) | Automatic for 20%, claim extra | Automatic (immediate) |
| NI savings | Yes ✓ | No ✗ | No ✗ |
| Employer saves NI | Yes ✓ | No ✗ | No ✗ |
| Reduces gross salary | Yes (affects mortgages) | No | No |
| Best for low earners | Yes | Yes (basic-rate relief even if you don't pay tax) | No (no relief if under personal allowance) |
| Best for higher-rate taxpayers | Yes (saves NI too) | Good (but must claim extra relief) | Good (but no NI saving) |
| Flexibility | Low (usually locked in) | High (can stop anytime) | Medium |
| Common in | Large employers, public sector | Personal pensions, SIPPs | Some workplace schemes |
Which Type Do I Have?
Check your payslip or ask your employer/pension provider. Here are the telltale signs:
- Salary Sacrifice: Your contract/payslip shows a lower gross salary than you agreed. Pension line might say "salary exchange" or "SMART pension".
- Relief at Source: Money comes out of your bank account after payday. Your payslip might not mention pension at all. Common with personal pensions and SIPPs.
- Net Pay: Payslip shows full gross salary, then pension deducted before tax but after NI.
Why Employers Offer Different Types
Salary sacrifice is the most tax-efficient for everyone, but it requires administrative setup and can affect mortgage applications for employees. Relief at Source is simpler to run and gives employees more flexibility. Net Pay schemes are gradually being phased out because they don't benefit low earners who don't pay tax (unlike Relief at Source, which gives them 20% boost anyway).
Why Employees Care
If you have salary sacrifice, you're getting the best deal - saving both tax and NI. But be aware it lowers your "official" salary, which matters for mortgage applications, life insurance, and statutory pay (maternity/paternity).
If you have Relief at Source and you're a higher-rate taxpayer, don't forget to claim your extra relief - it won't happen automatically. Use Self Assessment or call HMRC to adjust your tax code.
Common Questions (FAQ)
Can I choose which type I get?
Not usually - your employer's pension scheme determines the method. If you want a different type, you'd need to set up a personal pension (SIPP) separately, which will use Relief at Source.
Can I have multiple types at once?
Yes! You can have salary sacrifice through work and also pay into a SIPP using Relief at Source. Just make sure your total contributions don't exceed the annual allowance (£60,000).
Which type is best?
Salary sacrifice is most tax-efficient if you're staying with your employer and don't need a mortgage soon. Relief at Source is best for flexibility. Avoid Net Pay if you earn below the personal allowance.
I earn £10,000 - which type gives me tax relief?
Relief at Source will give you 20% boost even though you don't pay tax. Net Pay won't give you any relief. Salary Sacrifice still works but you're not saving much tax anyway at this income.
Does the type affect the annual allowance?
No - all three types count the same toward your £60,000 annual allowance. The only difference is the tax treatment.
Can I switch from one type to another mid-year?
Only if your employer offers both and allows switching. Most employers stick with one method for administrative simplicity.