Salary sacrifice for pension contributions

Salary sacrifice is a way of paying into a workplace pension that can cost you less for the same contribution. You agree with your employer to give up part of your salary, or a bonus, and in return your employer pays the same amount straight into your pension¹. Because the money never counts as your pay, it is not treated as your income for tax or, in most cases, National Insurance, which means a £100 pension contribution costs a basic-rate taxpayer £72².

Around 7.7 million employees in the UK currently use salary sacrifice to make pension contributions³. It is sometimes called a SMART scheme or salary exchange, but the mechanics are the same whatever the name¹. The government announced a significant change at Autumn Budget 2025: from 6 April 2029, only the first £2,000 a year of pension contributions made through salary sacrifice will be exempt from National Insurance, with contributions above that attracting both employer and employee National Insurance charges⁴.

How salary sacrifice works: part of your pay becomes an employer pension contribution

In a standard workplace pension, a percentage of your pay is put into the pension scheme automatically every payday⁷. Salary sacrifice changes how the money gets there. Instead of a deduction from your pay, you and your employer agree to a formal change to your employment contract: your gross salary goes down, and your employer pays the sacrificed amount into your pension as an employer contribution¹. The government's definition is straightforward: you agree to reduce your gross salary or sacrifice a bonus, and in return your employer pays the same amount into your pension⁴.

Because the contribution is technically an employer payment rather than your own, the arrangement is a genuine change to your contract, not just a payroll instruction. That has consequences, covered later, for everything from mortgage applications to maternity pay. It also means the arrangement must be set up properly: the agreement is only valid from the date the contract is drawn up between you and your employer, and it cannot be applied to pay you have already received⁸.

The scale of the arrangement is worth noting. HMRC estimates 7.7 million employees currently use salary sacrifice for pensions, and the reform taking effect in 2029 is expected to have a significant impact on 290,000 employers who operate such arrangements³. Of those employees, 3.3 million sacrifice more than £2,000 of salary or bonuses each year, which is the group most affected by the coming cap³.

Salary sacrifice cuts National Insurance, not just income tax

The core financial advantage of salary sacrifice is that it removes the contribution from your pay before both income tax and employee National Insurance are worked out. In some cases, this means you and your employer pay less tax and National Insurance¹. Your employer also saves, because employer National Insurance is charged on the lower salary. Employers do not pay National Insurance on pension contributions, but employees and self-employed people do, which is why routing a contribution through the employer side of the ledger avoids a charge that would otherwise apply¹⁰.

This favourable treatment is the survivor of a wider crackdown. From April 2017, the tax and National Insurance advantages of salary sacrifice were largely withdrawn for most benefits, and employees have since been required to pay tax and National Insurance on salary given up under other salary sacrifice or flexible benefit schemes³. A small set of arrangements kept their advantages: pension saving into a registered pension scheme, employer-provided pensions advice, employer-supported childcare, cycle to work schemes and ultra-low emission cars¹¹. Pensions are the largest of these survivors, and the government has retained income tax and National Insurance reliefs on pension contributions worth over £70 billion per year³.

The 2029 reform narrows the National Insurance advantage rather than abolishing it. The measure removes the exemption that keeps employer pension contributions under salary sacrifice outside Class 1 National Insurance, but only where arrangements exceed the annual £2,000 cap¹². All pension contributions, including those made via salary sacrifice, remain exempt from income tax, subject to the annual allowance of £60,000⁶.

A worked example: take-home pay and pension pot before and after

The clearest way to see the benefit is with a bonus. On a £30,000 salary with a £1,000 bonus, taking the bonus as pay means tax and National Insurance come off before it reaches you. If you divert it to your pension via bonus sacrifice, the full £1,000 goes into your pot¹³.

For regular contributions, the saving works the same way. A £100 pension contribution made via salary sacrifice costs a basic-rate taxpayer £72, because you save the income tax and the employee National Insurance that would otherwise be taken from that £100⁶. The same £100 contribution made from take-home pay would cost the full £100, or £80 under relief at source for a basic-rate taxpayer, with the provider claiming back the remaining £20 from the government⁵.

The long-term effect comes from compounding. An illustration of workplace pension contributions found that raising an employee contribution from 5% to 7% produced an extra £52,000 in the pot at age 68, and raising it to 8% produced an extra £79,000¹⁴. The value of your pot at retirement depends on how much you and your employer have contributed, and how well the underlying investments have performed¹⁵.

Two caveats apply. Salary sacrifice contributions are not tax deductible in the way some people assume: the saving comes from the lower taxable pay, not from a deduction you claim later⁸. And tax is payable on employer contributions above the annual allowance, so very large sacrifices can create a charge rather than a saving¹⁶.

The £2,000 cap on National Insurance savings from April 2029

The biggest change to salary sacrifice in a decade was announced at Autumn Budget 2025⁴. 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 sacrifice⁴. Earnings forgone above the £2,000 contribution limit for a tax year will be subject to employer and employee National Insurance at existing rates¹⁷. The House of Lords Library summarised the measure as capping National Insurance relief on salary sacrifice into pension schemes to the first £2,000 of pension contributions per person¹⁸.

The government's impact assessment gives a sense of who is affected. An estimated 56% of employees currently making typical pension contributions through salary sacrifice, around 4.3 million people, are fully protected by the £2,000 threshold, while 44% of employees using salary sacrifice for pensions would be impacted by the measure³. For those with contributions above the limit, the average additional employee National Insurance liability is estimated to be £84 in the first year of impact, tax year 2029 to 2030³. The government's motivation is scale: the forgone National Insurance from these arrangements was expected to nearly triple to £8 billion by tax year 2030 to 2031 if nothing changed³.

In practice, the cap reduces the saving rather than removing it. Which? gives the example of someone earning £40,000 who sacrifices 10% of salary, £4,000 in total: the £2,000 above the cap loses its National Insurance exemption, meaning missed savings of £160 a year⁶. You will still be able to pay more than £2,000 into your pension, but contributions above that level will be subject to employer and employee National Insurance⁶. Above the threshold, an employee would pay the full rate of National Insurance on their pension contributions¹⁹. Some independent commentary has suggested people consider increasing contributions before April 2029 while the full exemption still applies²⁰, though the details of how the cap will operate are still to be set out in secondary legislation following stakeholder engagement³.

Who can use salary sacrifice and the minimum wage limit

Salary sacrifice is not available to everyone, and the rules set a hard floor. It is not allowed if it means an employee's pay would fall below the National Minimum Wage⁴. Independent guidance puts the same point plainly: your reduced salary must remain above the minimum wage, and salary sacrifice is unlikely to work for those on low incomes because take-home salary is not allowed to fall below the national minimum wage⁶. The same rule is reported in coverage of the 2029 changes: salary sacrifice cannot reduce your cash earnings below the National Minimum Wage²¹.

The arrangement also requires an employer willing to run it. HMRC figures from 2019 showed that 30% of private sector employees and 9% of public sector employees used a salary sacrifice arrangement, so availability varies considerably by employer and sector¹⁹. Your employer cannot force you to give up part of your pay for a salary sacrifice scheme: it should be something you choose⁸. There is no credit check to enter a salary sacrifice scheme, as the money is taken from your pay rather than advanced to you⁸.

Self-employed people cannot use salary sacrifice at all, because there is no employer payroll to sacrifice from. They can still get pension tax relief on personal contributions, but not the National Insurance saving. For employees, the general pension tax rules frame what is possible: each year you receive tax relief on pension contributions of up to 100 per cent of your UK earnings, and there is no upper limit on the total amount of pension saving you can build up, though tax is payable on employer contributions above the annual allowance²².

Mortgages, maternity pay and other salary-linked entitlements

Because salary sacrifice lowers your contractual salary, it can affect how lenders assess your income²¹. A mortgage application typically looks at your gross salary, and a sacrificed amount reduces the figure the lender sees. Some lenders will add pension contributions back when assessing affordability, but that is a matter for each lender, and a lower contractual salary can reduce the amount a lender is willing to advance. If you are planning a mortgage application, a large salary sacrifice arrangement is worth mentioning to the lender or broker at the outset.

The same principle reaches statutory pay and benefits tied to earnings. Statutory maternity pay, statutory paternity pay, statutory sick pay and similar entitlements are calculated as a percentage of your pay, so a lower salary can mean lower statutory payments during periods of leave or illness. Benefits that overlap with contributory entitlements, such as Maternity Allowance and contributory Employment and Support Allowance, are themselves affected by other benefits they overlap with, and a reduced earnings record can change what qualifies²³. If you expect to take parental leave in the near future, ask your employer how your sacrificed salary would be treated in the statutory pay calculation.

A related point is the State Pension. Salary sacrifice is not likely to affect your entitlement to the State Pension, unless your lowered salary falls under the threshold at which you make National Insurance contributions⁸. For most people sacrificing a modest share of pay, earnings stay well above that threshold. The Bereavement Support Payment has replaced bereavement allowance, widow's pension, bereaved payment and widowed parent's allowance, and these bereavement benefits interact with National Insurance records in ways that a sustained drop in contributions could touch²⁴. If in doubt, check your National Insurance record and State Pension forecast before joining.

Child Benefit and the £100,000 personal allowance threshold

Salary sacrifice reduces your taxable income, which is why it is sometimes discussed as a way to manage thresholds. The two most commonly cited are the £100,000 personal allowance limit and the £60,000 Child Benefit threshold.

Above £100,000 of income, the Personal Allowance reduces by £1 for every £2 of income above the limit, irrespective of date of birth²⁵. Independent guidance states the same rule: if your salary is above £100,000, your basic personal allowance is reduced by £1 for every £2 you earn over the £100,000 limit²⁶. Because salary sacrifice lowers your taxable salary, it can pull income back below £100,000 and restore some or all of the Personal Allowance. The government has confirmed the 2029 reform will not change the impact of salary sacrifice on adjusted net income⁴, so this use of sacrifice survives the cap.

Child Benefit works on a similar cliff edge. If you or your partner have an individual income of £60,000 or more and you receive Child Benefit, you may be affected by the High Income Child Benefit charge²⁷. If you or your partner have an individual annual income of over £60,000, you will have to pay an income tax charge if you get Child Benefit²⁸. Reducing taxable income through salary sacrifice can bring income below £60,000 and reduce or remove the charge, though the National Insurance cap from April 2029 does not change this income tax effect.

For anyone using salary sacrifice to manage thresholds, the interaction with benefits and credits matters too. Pension contributions can affect the calculation of tax credits and means-tested benefits, and a lower salary changes the figures used²⁹. The general rule on pension tax relief is that full relief is given for payments made in the year, with no provision for carry backs³⁰, so threshold planning has to be done in advance rather than retrospectively.

Setting up, changing or leaving a salary sacrifice arrangement

Joining is a matter between you and your employer. Because salary sacrifice is a change to your employment contract, it needs a written agreement, and the arrangement is only valid from the date the contract is drawn up⁸. Ask your HR or payroll team whether the scheme exists, how the employer handles its own National Insurance saving, and what the arrangement means for benefits linked to your salary.

Changing or leaving is more restricted than joining. You cannot usually change your salary sacrifice arrangement whenever you like, and many employers allow changes only once a year²¹. You can opt out of salary sacrifice at any time, but if you were using it to finance something you own, for example through a cycle to work scheme, you must still pay off any outstanding amounts⁸. Life events such as maternity leave, redundancy or a significant change in circumstances are commonly treated as reasons to vary or end an arrangement, but the exact rules are set by your employer's scheme documentation.

For the 2029 cap specifically, employers and employees who operate or participate in salary arrangements for pension contributions are the people affected, and the details of the design and operation of the £2,000 contribution limit will be set out in secondary legislation in due course³. The government has also estimated a one-off administrative cost of £20 million for employers to implement the change³. If you are sacrificing more than £2,000 a year, it is worth asking your employer how they plan to handle contributions above the cap from April 2029, including whether the employer will continue passing its own National Insurance saving into your pot.

Salary sacrifice or relief at source: how the alternatives compare

Salary sacrifice is one of three ways a workplace or personal pension contribution can be collected, and the differences are mostly about tax mechanics. With relief at source, contributions are taken from your after-tax pay: the pension provider takes 80% from your salary and claims 20% of the amount you have contributed from the government⁶. Higher-rate taxpayers must claim the extra relief themselves, usually through a Self Assessment tax return. The full comparison is set out in salary sacrifice vs relief at source and relief at source or net pay.

The trade-offs are symmetrical. Salary sacrifice costs less for the same contribution and delivers automatic relief at your highest marginal rate, but it lowers your contractual salary, with the consequences for mortgages, statutory pay and salary-linked benefits described above. Relief at source leaves your salary untouched and is available through personal pensions to people whose employers do not run a scheme, including after leaving a job, but it delivers no National Insurance saving and requires higher-rate taxpayers to claim the extra relief themselves.

Whichever route is used, the underlying pension tax rules are the same: the government gives tax relief on pension contributions to encourage retirement saving³⁰, and for every £1 paid in you can end up with £1.25 in your pension pot as a basic-rate taxpayer²⁹. The choice between the collection methods is usually made by the employer when the scheme is set up, so the practical question for most employees is simply which method their workplace scheme uses, and whether the employer passes on its National Insurance saving. Free guidance on pension choices is available through Pension Wise, and the wider rules are covered in pension tax relief and workplace pensions.