Salary sacrifice is one of the most effective, and least understood, ways for employees to save tax. It is entirely legitimate and set out in HMRC guidance, but it changes your contract, so it is worth understanding properly.
What is salary sacrifice?
You agree with your employer to give up part of your salary in exchange for a non-cash benefit – most commonly an extra employer pension contribution, but sometimes childcare, cycle-to-work schemes or electric cars. Because your contractual pay is lower, you pay less Income Tax and National Insurance (HMRC: salary sacrifice and PAYE).
How it compares with a normal pension contribution
With a standard net pay arrangement, your pension contribution is deducted before Income Tax, but National Insurance is still charged on your full salary. With salary sacrifice, the contribution comes out before both. For a basic-rate taxpayer, that extra 8% NI saving can make a noticeable difference. Some employers also pass on part of their own 15% employer NI saving.
Worked example
Consider a £40,000 salary in England with a 5% pension contribution. Under a net pay arrangement, National Insurance is charged on the full £40,000. Under salary sacrifice, it is charged on £38,000, saving 8% of £2,000 – that is £160 a year – while the same amount reaches the pension. Try both options in our Take-Home Pay Calculator.
Trade-offs to consider
- Mortgage applications – some lenders look at your reduced salary.
- Statutory payments – things like Statutory Maternity Pay are based on earnings, so a lower salary could reduce them.
- Life cover – if your employer's death-in-service benefit is a multiple of salary, check which figure is used.
- Minimum wage – sacrifice cannot take your cash pay below the National Minimum Wage.
Is it right for you?
For most employees paying into a pension anyway, salary sacrifice increases take-home pay for the same contribution. Check how your employer's scheme works, and ask HR how it affects other benefits before you agree.
