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  • Writer's pictureJordan White DipPFS

Salary Sacrifice: The most tax efficient way to save into your pension

Updated: Aug 7, 2023

Salary Sacrifice is similar to a standard employer (workplace) pension. You pay in a percentage of your salary and your employer also makes a contribution. Under auto-enrolment rules, an employee contributes 5% of their salary and an employer contributes 3% of the employee’s salary.

As you may already know, pensions are a very tax efficient way of saving for your retirement. Not only do you get tax relief on your pension contributions, but you also get the bonus of ‘free’ money from the contributions your employer also makes on your behalf.

The key difference with a Salary Sacrifice arrangement is where national insurance contributions come into play.

Salary Sacrifice, also referred to as Salary Exchange, means just that. You sacrifice some of your salary in exchange for pension contributions and reduced tax. It’s a contract you make with your employer that effectively reduces your gross salary. This has benefits for both you and your employer.

Benefits of Salary Sacrifice vs a standard workplace pension

Let’s say you earn £30,000 a year.

A standard workplace pension scheme deducts your pension contributions from your gross salary i.e. £30,000 in our example.

So, if I pay 5% into my pension, that’s £1500 a year. This is paid into your pension BEFORE your salary is subject to income tax. So, it’s effectively a tax-free payment into your pension. This is why pensions are described as tax efficient. However, national insurance contributions are deducted from your gross salary.

So, in our example of £30,000 gross salary:

  • £30,000* is subject to national insurance contributions

  • £28,500* is subject to income tax (£30,000 minus 5% pension contributions)

*Minus personal allowances

Salary Sacrifice pension example

If I want to pay 5% into my pension, I have to agree with my employer that they will reduce my salary by 5% and put that amount into my pension instead.

On paper, and in the eyes of HMRC, a £30,000 salary using 5% as salary sacrifice, is now a salary of £28,500.

Our salary still comes to £30,000 but is effectively divided up:

  • £1500 tax free payment into your pension

  • £28,500* is subject to national insurance contributions

  • £28,500* is subject to income tax

*Minus personal allowances

With salary sacrifice, the key benefit is that national insurance contributions are paid on a lower amount of salary, thereby reducing your payments and increasing your take-home pay.

Here’s a comparison of your take-home pay on a £30,000 salary to illustrate:

Standard workplace pension arrangement:

  • Gross Salary: £30000

  • Pension Contributions: £1500 (5% of gross salary)

  • Income Tax: £3186 – 20% basic rate on £28,500 (on the amount over the personal allowance)

  • National Insurance: £2,091.60 – based on £30,000 salary (on the amount over the primary earnings threshold)

  • Take-home pay: £23,222.40

Salary Sacrifice arrangement:

  • Gross Salary: £28500

  • Pension Contributions: £1500 (5% of original £30,000 gross salary)

  • Income Tax: £3186 – 20% basic rate on £28,500 (on the amount over the personal allowance)

  • National Insurance: £1,911.60 – based on £28,500 salary (on the amount over the primary earnings threshold)

  • Take-home pay: £23,402.40

Salary Sacrifice puts back an extra £180 in your pocket that would have been deducted as national insurance contributions via the normal workplace pension contributions method.

You can see how the salary sacrifice method can reduce the amount of national insurance you pay and effectively keep more of your salary.

If you earn bonuses, making a pension contribution - through salary sacrifice or not - is a simple way of reducing tax on your bonus,

A potential extra bonus

On top of reduced national insurance contributions for you, also is reduced national insurance contributions for your employer. An employer has to pay national insurance on behalf of their employees too.

So, if you opt in to a Salary Sacrifice arrangement, your employer will be making savings too. If a large company 'reduces' the salaries of all its employees, the national insurance savings can be pretty substantial.

They could choose to pay those savings into your pension although many use the extra savings to cover the admin costs of running the salary sacrifice. It’s not compulsory, but if they do then you’ll get a bit more free money from your employer on top of their regular pension contributions.

Potential problems with Salary Sacrifice

Although I’m a big fan of salary sacrifice for maximising take-home pay and saving for retirement, there could be some issues.

Because you’re effectively reducing your gross salary, this can have a knock-on effect when you’re applying for things that are tested on how much you earn.

The most common one is a mortgage. But it could affect things like other types of loan or claiming certain benefits.

From personal experience, having had two remortgages, I’ve always put down my gross salary and never had any problems.

If you do encounter any issues, your employer does have to give you the option of a standard workplace pension. So in theory you could switch to that one if you need to – just bear in mind you might not be able to switch back and forth with great flexibility.

In terms of other workplace benefits that are based on your salary, a key one is life cover/death in service. If you're not sure how this is calculated, check with your employer by simply asking 'are any of my workplace benefits affected by entering a salary sacrifice scheme?'

There is only so far you can reduce your salary via Salary Sacrifice. If you're already on a low income, you can't use it if it means your salary then goes below the minimum wage.


Salary Sacrifice is a great way of:

  • reducing your national insurance contributions

  • saving for retirement, like a standard workplace pension

  • increasing your take-home pay compared to a standard workplace pension.

While Salary Sacrifice sounds like a big positive, it is not actually as common as you would think. Running an alternative pension scheme will incur admin costs for the employer.

If you’re not sure if your company offers Salary Sacrifice, the first thing to do is ask.



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