Salary sacrifice

Giving up salary for pension contributions saves National Insurance as well as income tax. It also has trade-offs.

Salary sacrifice is one of the few genuinely free wins in personal finance, and a surprising number of people who have access to it don't use it.

How it works

You agree with your employer to give up a portion of your gross salary. In exchange, they pay that amount into your pension as an employer contribution.

Your contractual salary genuinely reduces. That's what makes it work, and it's also where every one of the trade-offs comes from.

Why it beats an ordinary contribution

An ordinary pension contribution saves you income tax. Salary sacrifice saves income tax and National Insurance, because the money never counts as your earnings in the first place.

For a basic-rate taxpayer, employee National Insurance is 8% on earnings in the main band. Sacrificing £1,000 of salary therefore saves £80 of National Insurance on top of the income tax relief you'd have received anyway. For higher earners above the upper threshold the employee rate drops to 2%, so the National Insurance saving is smaller — but it's still there, and it's still free.

There's a second saving that's often larger. Employers pay National Insurance on salary too, at 15%. Sacrificed salary saves them that as well, and many employers pass some or all of it into your pension. Where they do, the total going in can be materially more than you gave up.

Ask whether your employer shares the saving. Some do automatically, some do if asked, some don't at all — and the difference is real money.

Where it's especially powerful

Crossing a tax cliff. Between £100,000 and £125,140 the Personal Allowance tapers away at £1 for every £2 earned, producing an effective marginal rate of 60%. Sacrificing salary to bring adjusted income below £100,000 recovers the allowance, and is one of the most effective things a person in that band can do.

The High Income Child Benefit Charge. Similar logic — reducing adjusted net income below the relevant threshold can preserve Child Benefit that would otherwise be clawed back.

Protecting a tapered Annual Allowance. For very high earners, reducing threshold income can restore some or all of a tapered allowance.

In each case the mechanism is the same: salary sacrifice reduces the income figure the rule is measured against, in a way that ordinary pension contributions don't always achieve as cleanly.

The trade-offs

Your salary really is lower, and things calculated from salary change accordingly.

Mortgage borrowing. Lenders assess affordability on gross salary. A lower salary can mean a smaller mortgage offer. Some lenders will add sacrificed pension contributions back for affordability purposes and some won't. If you're planning to buy or remortgage in the next year or so, that's worth checking before you sacrifice.

Statutory payments. Maternity, paternity and adoption pay, statutory sick pay and redundancy pay are calculated from actual salary. Sacrificing before a period of statutory pay can reduce it. Many employers will pause sacrifice arrangements around parental leave — worth asking.

Death in service cover. Often expressed as a multiple of salary. Check whether yours is based on pre- or post-sacrifice salary, because the difference could be several times your annual income.

The National Minimum Wage floor. Sacrifice can't take you below the minimum wage, which limits it for lower earners.

State benefits. Sacrifice reduces the earnings your National Insurance record is built on. In practice this rarely affects State Pension entitlement for people earning comfortably above the thresholds, but it's a genuine consideration at lower incomes.

It's a contractual change, and reversing it isn't always straightforward. Most employers allow changes at set points or on a life event, not on demand.

Who it suits

Broadly: employees earning comfortably above the minimum wage, who aren't about to apply for a mortgage, who aren't approaching a period of statutory pay, and whose employer offers it. For that group it's close to free money and the main question is why they aren't already doing it.

It's less clear-cut for lower earners, for anyone whose borrowing plans depend on their stated salary, and for anyone near a parental leave period.

How to find out

Ask HR three questions: do we offer salary sacrifice, do you share the employer National Insurance saving, and is death in service based on pre- or post-sacrifice salary. Those three answers tell you almost everything you need.

This article is for general education only and isn't personal advice. Salary sacrifice changes your contractual pay and affects borrowing, statutory payments and benefits — check the specific effects on your situation before entering into it.