Salary Sacrifice

Official Definition

According to HMRC, salary sacrifice is an arrangement where an employee gives up the right to part of their cash salary in return for a non-cash benefit.

What It Is (Plain English)

Salary sacrifice is when you agree with your employer to receive less salary in exchange for a benefit - usually a pension contribution, but could also be things like childcare vouchers or a company car. Because you're receiving less salary, you pay less tax and National Insurance.

Why Employers Offer It

The primary reason employers offer salary sacrifice is that it reduces their tax costs. When an employee's salary is reduced, the employer pays less National Insurance (13.8% on the sacrificed amount). For example, if an employee sacrifices £5,000 to pension, the employer saves £690 in employer NI. Many employers use these savings to enhance employee benefits or pass some back to employees through increased pension contributions. Beyond the direct cost saving, offering salary sacrifice schemes helps attract and retain talent by providing tax-efficient benefits without increasing base salary costs, and demonstrates commitment to employee financial wellbeing.

Why Employees Use It

For employees, salary sacrifice is primarily about tax efficiency. When you sacrifice salary, you avoid paying both income tax (20%, 40%, or 45% depending on your rate) and National Insurance (12% or 2%) on that amount. This means that every £1 you sacrifice only reduces your take-home pay by around 60-70p, while still going fully toward your chosen benefit. For pension contributions specifically, this makes salary sacrifice significantly more efficient than contributing from your net salary - you get more into your pension for the same reduction in take-home pay. The tax savings also make other benefits like childcare vouchers or cycle-to-work schemes much more affordable than paying for them yourself.

How It Works

1. You agree with your employer to reduce your contractual salary
2. Your employer provides the benefit instead (e.g., pension contribution)
3. You only pay tax and NI on the reduced salary
4. The benefit is provided tax-free (or at reduced tax)
5. Your employer saves on their NI too

Examples

Example 1: £5,000 Pension Contribution

Example 2: £10,000 Pension Contribution (Higher Rate Taxpayer)

Benefits

• Lower tax bill - Pay tax on lower salary
• Lower NI - Save 12% (or 2% above £50,270) in National Insurance
• Employer saves too - Good employers may pass some savings to you
• Larger pension - More efficient than net pay contributions
• State Pension protected - Pension contributions don't reduce State Pension entitlement

Drawbacks

• Lower gross salary - Affects mortgage applications, credit applications
• Benefits calculated on salary - May reduce life insurance, critical illness cover
• Child Benefit - Based on adjusted income (after sacrifice), but other benefits use gross
• Statutory payments - Maternity/paternity pay based on lower salary
• Less flexibility - Usually locked in for tax year or scheme period
• Not all benefits qualify - HMRC restricts what can be salary sacrificed

Is Salary Sacrifice Right for You?

Good for you if:

• You're planning to stay with employer medium-term
• You don't need mortgage in near future
• You're saving for pension long-term
• You're a higher/additional rate taxpayer (bigger savings)

Maybe reconsider if:

• Planning to apply for mortgage soon
• On maternity/paternity leave soon
• Earning close to benefit thresholds (£60k, £100k)
• Need maximum flexibility with salary

Common Questions (FAQ)

Official Resources

• HMRC: Salary sacrifice for employers
• HMRC: Approved benefits for salary sacrifice
• The Pensions Regulator