What is salary sacrifice for pensions?
Salary sacrifice (also called salary exchange) is an arrangement where you agree to reduce your gross salary in exchange for your employer paying the same amount into your pension. Your employment contract is amended to reflect the lower salary.
Example: You earn £30,000 and want to contribute £2,000 annually to your pension. Under salary sacrifice, your contractual salary drops to £28,000 and your employer pays £2,000 into your pension on your behalf. You never receive the £2,000 as income, so you never pay tax or National Insurance on it.
How much do you save?
You save both Income Tax and National Insurance on the sacrificed amount:
| Income band | Income Tax | National Insurance | Total saving |
|---|---|---|---|
| Basic rate (£12,571–£50,270) | 20% | 12% | 32% |
| Higher rate (£50,271–£125,140) | 40% | 2% | 42% |
| Additional rate (£125,141+) | 45% | 2% | 47% |
Example: If you sacrifice £3,000 and you're a basic-rate taxpayer, you save £960 (32% of £3,000). You pay £2,040 out of your net pay, but your pension receives the full £3,000.
Your employer saves too
Employers pay 13.8% National Insurance on salaries above £9,100 per year. When you sacrifice salary, they save this 13.8% on the sacrificed amount. Many employers pass this saving back to you by adding it to your pension contribution.
Example: You sacrifice £3,000. Your employer saves £414 (13.8% of £3,000) in NI. They add this to your pension, so your pension receives £3,414 instead of £3,000. Check your workplace scheme rules to see if your employer does this.
Salary sacrifice vs relief at source
There are two main ways to get tax relief on pension contributions:
Relief at source
You pay contributions from your net (after-tax) salary. The pension provider claims back basic-rate tax (20%) from HMRC and adds it to your pension. Higher and additional-rate taxpayers claim the extra 20% or 25% relief through their Self Assessment tax return.
Downside: You still pay National Insurance on the full salary. You lose 12% or 2% compared to salary sacrifice.
Salary sacrifice
You never receive the salary, so you avoid both Income Tax and National Insurance. Your employer pays the contribution directly into your pension. No need to claim relief via Self Assessment.
Comparison: A basic-rate taxpayer contributing £3,000 saves £960 with salary sacrifice, but only £600 (20% tax relief) with relief at source. Salary sacrifice saves an extra £360.
Annual allowance
The pension annual allowance is £60,000 for 2025-26. This is the maximum you and your employer can contribute to your pension in a tax year while receiving tax relief.
If you earn less than £60,000, your limit is 100% of your earnings. Someone earning £40,000 can contribute up to £40,000.
Tapered annual allowance
If your adjusted income exceeds £260,000, your annual allowance reduces by £1 for every £2 over £260,000, down to a minimum of £10,000. This affects high earners.
Carry forward
You can carry forward unused allowance from the previous three tax years. If you contributed £30,000 last year, you have £30,000 unused. This year you could contribute up to £90,000 (£60,000 this year + £30,000 carried forward).
Does salary sacrifice affect statutory pay?
Your reduced salary is used to calculate statutory payments like:
- Statutory maternity pay
- Statutory paternity pay
- Statutory sick pay
- State pension contributions
Most workplace schemes let you opt out of salary sacrifice temporarily (for example, when planning maternity leave) to protect these benefits. Check your scheme rules before committing.
Salary sacrifice and the lifetime allowance
The lifetime allowance was abolished in April 2024. You no longer face a tax charge if your pension pot exceeds a set amount. However, lump sum limits still apply when you take benefits.
Who can use salary sacrifice?
Salary sacrifice is available if:
- Your employer offers it (not all do)
- Your salary after sacrifice stays above National Minimum Wage
- You have a written agreement to reduce your contractual salary
Self-employed people cannot use salary sacrifice because they do not receive employment income. They make contributions via relief at source or net pay instead.
How to set up salary sacrifice
Your employer must provide a salary sacrifice agreement document. You sign to confirm:
- The amount of salary you will sacrifice
- Your new gross salary
- The pension contribution amount
- The date the arrangement starts
This changes your employment contract. You cannot reverse it mid-year unless your scheme allows opt-outs at specific review dates.
Salary sacrifice and student loans
Your student loan repayments are based on your reduced salary after sacrifice. If you sacrifice £3,000, you repay 9% less on that £3,000 (£270 per year). For some, this is a benefit. For others, it means slower loan repayment.
Plan 1 and Plan 2 loans work the same way. Postgraduate loans are also based on gross salary, so salary sacrifice reduces repayments across all loan types.
Can you sacrifice your entire salary?
No. Your salary after sacrifice must stay above:
- National Minimum Wage (£11.44/hour from April 2024)
- Your employer's minimum salary policy
HMRC also applies an income test for tax credits and Universal Credit based on gross salary before sacrifice, so reducing salary too far may affect benefit entitlement.