Pension contributions via salary sacrifice

An employee may choose to give up part of their salary in exchange for their employer paying the equivalent amount directly into their pension as an employer contribution.

1. How it works

For employees:

• The sacrificed salary is not treated as a benefit in kind, so it is exempt from income tax and National Insurance (NI).
• If the employee were to make the same contribution personally, they would receive tax relief, but not a refund of the NI already paid on that income. Depending on their earnings, this could mean a loss of 8% or 2% of the amount contributed—or a mix of both. By using salary sacrifice, the employee effectively retains this amount as part of their overall net benefit.

For employers:

• Whether the employer pays salary or makes a pension contribution, the cost is deductible for corporation tax purposes.
• The key advantage lies in the employer’s NI saving. Typically, employers pay 15% NI on earnings above £5,000.
• Some employers may choose to share part of this NI saving with the employee, offering an additional benefit.

Current NI thresholds and rates can be found here.

2. Interaction with tapered annual allowance

Salary sacrifice does not reduce the threshold income for tapered annual allowance purposes if the arrangement was made after 8 July 2015. This is because any salary sacrifice arrangement made after this date is added back into the threshold income as part of the calculation.

This means salary sacrifice pension contributions won’t help avoid the tapered annual allowance.

HMRC does not require employers to inform them when a salary sacrifice arrangement is put in place. However, if there are points of legal uncertainty, HMRC does offer a clearance service. Employers can request formal approval from HMRC if they are unsure about the effectiveness of their arrangements, but this is typically only necessary where the legal position is unclear. The documents that would be useful for review can be found here.

Further considerations

Salary sacrifice must not reduce a salary below the minimum wage. The definition of ‘salary’ can affect various aspects of an employee’s finances and borrowing capacity, so these implications should be carefully considered.

• Borrowing and Lending: Personal loans and mortgages are often calculated based on salary or multiples of salary. A reduced salary following a sacrifice arrangement may lower the amount an employee is able to borrow.
• Permanent Health Insurance: This type of cover is usually based on a percentage of earnings before incapacity. Payments from such policies are typically free from tax and NI. If salary is reduced due to sacrifice, the benefit payable may also be reduced.
• Payslips and Clarity: Salary sacrifice can make it difficult for employees to determine what their ‘salary’ is for different purposes, and what level of benefits or borrowing they may be entitled to. To help with this, some employers show both the pre- and post-sacrifice salary on payslips.
• Other Employer Benefits: Salary sacrifice may also affect other benefits, such as life cover (often based on a multiple of salary) and bonus payments (if calculated as a percentage of salary). Some employers, however, base these benefits on notional earnings (i.e., the pre-sacrifice salary).
• Tapered annual allowance: As salary sacrifice does not reduce the threshold income, relief at source personal contributions may be more effective for high earners trying to regain their full annual allowance.

5. Summary

Salary sacrifice is a powerful tool for pension planning. It can increase contributions, reduce tax and NI, and help reclaim personal allowance. But it’s not a solution for avoiding the tapered annual allowance, and care must be taken with contractual and financial implications.