Salary sacrifice vs relief at source: how each one works

There are two main ways a workplace pension contribution can leave your pay, and they are not the same thing. Under relief at source, your contribution is taken from pay you have already paid tax on, and the pension provider claims basic-rate tax relief from HMRC and adds it to your pot. Under salary sacrifice, you agree to give up part of your gross salary and your employer pays that amount straight into your pension instead¹.

The practical difference is what gets relief and when. Relief at source gives 20% upfront, and higher or additional-rate taxpayers must claim the rest separately³. Salary sacrifice builds the tax saving into a lower salary, and because your pay is lower you and your employer also pay less National Insurance, which often means your take-home pay is higher⁴.

The method is usually set by the scheme your employer runs, not chosen by you. Salary sacrifice is an agreement between you and your employer, and you can opt out at any time⁶. From April 2029 the National Insurance advantage of salary sacrifice is capped at £2,000 a year, which changes the sums for anyone contributing more than that⁷.

How relief at source works: £20 added to every £80 you pay in

Relief at source is the method most personal pensions and many workplace schemes use. Your contribution is taken from your pay after tax has been deducted, and the pension provider then claims basic-rate tax relief from the government and adds it to your pot³. The effect is that every £80 you pay in becomes £100 in the pension.

The government's own worked example makes the mechanics clear. Jane's monthly pension contribution figure on her payslip is £80, which is just her own contribution; her provider claims £20 from the government, so £100 a month goes into her pension².

The advantage is that the top-up happens automatically and does not depend on whether you pay income tax. If you have little or no earnings and are in a relief at source scheme, you still get tax relief, and if you do not pay income tax because your income is low you get it automatically¹⁰. That is why the Pensions Regulator has pointed out that if employers choose a scheme operating relief at source, all their low paid staff will be able to have tax relief¹².

The catch is the ceiling on the automatic top-up. Relief at source gives 20% upfront; higher and additional-rate relief must be claimed separately³. If you are entitled to more than 20%, you need to claim it yourself⁵.

How salary sacrifice works: giving up pay for a pension contribution

Salary sacrifice is when you agree to reduce your gross salary, or sacrifice a bonus, and in return your employer pays the same amount into your pension⁶. You give up part of your salary and your employer pays it straight into your pension¹. It is sometimes known as a SMART scheme¹.

The tax treatment is different from relief at source in a way that matters. Salary sacrifice contributions are not tax deductible, because you have already benefited from reduced tax on your lower salary¹³. There is no separate relief to claim and nothing to add on top: the saving is baked into the arrangement.

Because your salary is lower, you and your employer pay less National Insurance, and in some cases less tax too¹. The employer saves National Insurance on the sacrificed wages and may pass some or all of that saving on to you¹⁵. That employer saving is the reason many schemes offer salary sacrifice in the first place, and it is why the arrangement can leave you better off than paying the same amount from taxed pay.

Salary sacrifice can be used by any type of pension scheme, and members agree to a reduction in salary in exchange for a contribution made by their employer¹⁶. You agree with your employer that you will give up a fixed amount of salary to be paid into your pension¹⁷.

Salary sacrifice or relief at source: what each one saves you

The two methods produce different results for the same contribution, and the difference comes down to National Insurance.

Under salary sacrifice, reducing your salary cuts your National Insurance payments as well as your tax¹⁶. Since your salary is effectively lower, both you and your employer pay reduced National Insurance, which often means your take-home pay may actually be higher¹⁸. That is the central attraction: you can put more into your pension without your take-home pay falling by the same amount.

Under relief at source, your National Insurance position is unchanged. You pay National Insurance on your full salary, and the pension top-up comes only in the form of tax relief. The benefit is the automatic 20% and the fact that it works even for people with little or no earnings.

There is a further difference in who can benefit. Salary sacrifice is unlikely to work for those on low incomes, because your take-home salary is not allowed to fall below the National Minimum Wage¹³. Salary sacrifice cannot reduce your cash earnings below the National Minimum Wage¹⁹. That rule effectively excludes many part-time and lower-paid workers from the arrangement, which is precisely the group relief at source serves best.

Higher-rate taxpayers and claiming extra relief

If you pay tax above the basic rate, relief at source leaves you short unless you act. If you are entitled to more than 20%, you need to claim it yourself⁵. Higher and additional-rate taxpayers in a relief at source scheme must claim their full tax relief by completing a Self Assessment tax return¹².

The amounts are worth claiming. You may need to proactively claim the extra 20% or 25% tax relief you are entitled to⁸. In practice that means a higher-rate taxpayer claims a further 20% and an additional-rate taxpayer a further 25%, with the claim made through Self Assessment²⁰.

Self-employed higher and additional-rate taxpayers face the same task: you need to claim this back yourself in your Self Assessment tax return²¹. The claim is not automatic and does not happen because HMRC knows your tax band.

Under salary sacrifice there is nothing to claim. Because the relief has already been given through the lower salary, the arrangement is complete once the contribution is made¹⁴. For a higher-rate taxpayer this removes an administrative step, though it also means the timing of the benefit is different: you feel it in every payslip rather than as a lump sum after you file.

If you are a Scottish taxpayer, the rates and bands differ from the rest of the UK, and your pension provider claims tax relief from the government at the basic 20% rate and adds it to your pension pot⁴. The rate at which you personally pay tax, and therefore the extra relief you may be due, depends on Scottish bands.

Non-taxpayers, low earners and the self-employed

This is where the two methods diverge most sharply, and where the choice of scheme matters more than any decision you make.

In a relief at source scheme, you will still get tax relief if you have little or no earnings¹⁰. If you do not pay income tax because you are on a low income, you automatically get tax relief². Non-taxpayers can still get tax relief on their own or someone else's contributions up to a certain limit²².

Under a net pay arrangement, the opposite applies: if you do not pay tax, you do not get tax relief, for example because you earn less than the tax threshold². And staff who do not pay income tax will not get tax relief whichever tax relief method the scheme uses¹². The government has acknowledged that people whose income is below the personal allowance are not as well off overall if their employer uses a net pay scheme rather than a relief at source scheme²³.

The self-employed sit outside salary sacrifice entirely. Self-employed people are not covered²⁴. They also do not receive a payslip from an employer, since an employer does not have to provide one if you are not an employee or worker, for example a contractor or freelancer²⁵. Their route to relief is a personal pension claimed through Self Assessment²¹. There were 5.37 million individuals with at least one self-employment income source in the tax year 2022 to 2023, of whom 3.53 million were taxpayers²⁶.

A contribution reaches the pension by a different route under each method, which is why the tax and National Insurance results differ.

Limits on tax relief: your earnings cap what you can pay in

Tax relief is generous but not unlimited, and the limits apply whichever method you use.

You can get tax relief on what you pay in, up to 100 per cent of your earnings, as long as you are under 75². You can get tax relief on pension contributions up to 100% of your earnings, or £3,600 if your earnings are lower⁹. Stakeholder pensions follow the same principle: tax relief on contributions of up to 100 per cent of your earnings each year, depending on an annual allowance²².

The annual allowance is a separate ceiling on how much can receive relief in a tax year. The maximum contribution you can earn tax relief on in a year is £60,000, which is called the annual allowance¹¹. Relief is available if you do not pay in more than you earn and all payments in are less than the annual allowance, each tax year until age 75³.

The two limits work together. Your earnings cap what can attract relief, and the annual allowance caps the total that can benefit in a year, including contributions from you, your employer and any third party. If you have unused allowance from earlier years, carry forward rules may allow more, but the earnings cap still applies.

Tax relief itself is simply something you can claim to reduce your overall tax bill¹¹, and the amount of tax you pay can also be reduced by tax reliefs if you qualify for them²⁷. For pension contributions, the relief is delivered either through the provider's claim, through your tax code, or through your salary, depending on the method.

The £2,000 cap on National Insurance savings from salary sacrifice

The National Insurance advantage of salary sacrifice is being curtailed. From April 2029, the amount that is exempt from National Insurance contributions will be capped at £2,000 a year for employee contributions made via salary sacrifice⁶. Earnings forgone above the £2,000 contribution limit for a tax year will be subject to National Insurance⁷.

The change was announced at Autumn Budget 2025⁶. It caps National Insurance relief on salary sacrifice into pension schemes to the first £2,000 of pension contributions per person²⁸. From 6 April 2029, an employer and employee National Insurance charge applies to pension contributions above £2,000 per annum made via salary sacrifice²⁹.

What it means in practice depends on how much you sacrifice. The government estimates that 7.7 million employees currently use salary sacrifice to make pension contributions, and that 3.3 million of them sacrifice more than £2,000 of salary or bonuses⁷. It also estimates that 56% of employees currently making typical pension contributions through salary sacrifice will be unaffected⁷.

For those above the cap, the effect is a National Insurance charge on the excess. Contributions above the cap will attract National Insurance for both you and your employer, while income tax relief on contributions is unaffected³⁰. The measure removes the Optional Remuneration Arrangements excluded exemption for employer pension contributions for Class 1 National Insurance contributions where the arrangement exceeds the annual cap⁷.

What can change your contributions: leave, sickness and pausing payments

Salary sacrifice is an agreement about your pay, so anything that changes your pay changes the contribution.

You can normally change the amount you sacrifice, increasing or decreasing it, but your employer may have rules about when, for example if you have a relevant lifestyle event such as getting married¹⁴. Many employers allow changes only once a year¹⁹. A salary sacrifice arrangement should also allow changes when a major lifestyle event occurs, such as getting married, starting a family, or adjusting your pension after a divorce and pension sharing order¹⁵.

The knock-on effects are worth knowing before you sign up. If you qualify for sick pay or holiday pay, the amount you receive will be less, because those are usually calculated from your lower salary¹³. A lower salary could also affect percentage-based pension contributions and pay rises¹⁵. Other benefits linked to salary can be affected too, including sick pay, working tax credit or child tax credit, the State Pension, death benefits and overtime¹⁴.

On maternity leave, you and your employer continue to make pension contributions if you are getting paid, based on your actual pay during that time³¹. If you are not getting paid, your employer still has to make pension contributions in the first 26 weeks of your leave; after that it only has to if your contract provides for it³¹. When you take unpaid leave, you may be able to make pension contributions if you want³².

Salary sacrifice is not likely to affect your entitlement to the State Pension, unless your lowered salary is under the threshold to make National Insurance contributions¹³. You can opt out of salary sacrifice at any time, though if you were using it to finance something you own, such as a leased car, you must still pay off outstanding amounts¹³.

If something goes wrong with your workplace pension, the Financial Ombudsman Service can look at complaints about pensions organised by employers³³. Free, impartial guidance on pension options is available from Pension Wise, and MoneyHelper covers the basics of personal and workplace pensions³.