Salary Sacrifice Pension Scheme for Employees

Salary sacrifice pension schemes can be a beneficial option for employees who want to contribute towards a workplace pension in a tax efficient way.

Sometimes called a salary exchange pension scheme workers consent to sacrificing a portion of their wages and in exchange their employer agrees to pay the ‘sacrificed’ earnings directly into the employees’ workplace pension.

Through the decrease in wages you can be eligible for a reduction in both income tax and national insurance contributions giving you a greater take home pay at the same time as paying into your pension fund.

The pension salary sacrifice scheme is a supported program by the government mainly aimed at helping workers reduce their tax bill whilst saving for retirement at the same time.

A salary exchange can cover different types of benefits and requires changing your employment contract to legally confirm the reduction of your salary.

Along with an improved take home pay and tax savings entering into a salary sacrifice scheme can influence future credit applications, redundancy payments, statutory maternity pay, and other benefits.

It’s recommended to evaluate all possible results, both positive and negative, before enrolling in a salary sacrifice pension scheme to ensure you meet your financial goals in the short term and in retirement.

What are the advantages of a pension salary sacrifice scheme?

Providing a pension through salary sacrifice can offer employees some meaningful financial advantages including:

• Higher take home income. Workers will experience a rise in their take home income as a result of the tax benefits from reduced income tax and national insurance payments.
• Employees have the option to allocate their extra take home pay towards their pension savings.
• Employers also have the choice to contribute their national insurance savings towards their employees’ pensions which will increase their pension pots even more.

How do I join a salary sacrifice pension scheme?

Your employer should let you know if they offer a salary exchange pension scheme and obtain your consent before enrolling you on the scheme.

Signing up for pension salary sacrifice arrangement is voluntary and you must agree in writing to the amendment to your contract or acknowledge it through a formal agreement letter.

If you decline the option to join a salary sacrifice pension scheme, employers should handle your opt out accordingly and remain responsible for paying your pension contributions to a pension that doesn’t require a salary exchange.

To be eligible your pay after the sacrifice has been taken off must be above the national minimum wage.

Do you pay less tax with a salary sacrifice pension?

For employees one of the main benefits to a pension salary exchange is that you will typically pay less income tax and national insurance.

Given that salary sacrifice schemes involve a deduction from gross salary, the employer deducts an amount from an employee’s gross earnings (before tax is taken) in this case to cover a workplace pension contribution.

The end result is that you gain some tax free income because your reduced salary automatically lowers both your income tax and class 1 national insurance deductions.

Reducing your top rate of tax:

In some cases the amount of income sacrificed can lower the highest rate of tax paid on your remaining salary.

For example this would be of benefit to a higher rate taxpayer if they can sacrifice enough of their salary to bring their pay below either the addtional rate (45%) or the 40% income tax threshold.

How do you calculate a salary sacrifice pension tax saving?

We have set out an example of how to calculate the salary sacrifice pension tax saving based on a £35,000 per annum salary with no other deductions or tax code allowances in the 24/25 tax year.

In this example the pension contribution is paid by both the employer and employee at a rate of 6% of the £35,000 gross salary which works out at £4,200 in total for the year.

Personal allowance:

• £12,570 tax free allowance.

Taxable income:

• £22,430 before salary sacrifice.
• £20,330 after salary sacrifice.

Income tax:

• £4,486 before salary sacrifice.
• £4,066 after salary sacrifice.

Employee NI contribution:

• £1,794 before salary sacrifice.
• £1,626 after salary sacrifice.

Net take home pay before: £27,040.

Net take home pay with salary sacrifice: £27,208.

Change in net take home pay: £168 per annum.

What are the downsides of a salary sacrifice pension?

Opting for a salary sacrifice could influence your eligibility for state benefits and tax credits, so it’s crucial to carefully weigh the potential impacts before amending your employment contract.

Salary sacrifice can have an impact on an employee’s eligibility for benefits tied to their earnings and can include life insurance, contribution based benefits, earnings related benefits, work related benefits and income related benefits.

Salary sacrifice and contribution-based benefits:

• Incapacity Benefit.
• Jobseeker’s Allowance (JSA).
• State Pension.

Salary sacrifice and Earnings-related benefits include:

• Maternity Allowance.
• The State Second Pension.

Salary sacrifice and work-related payments:

• Statutory Maternity Pay.
• Statutory Sick Pay.

Salary sacrifice and Tax Credits

• Working tax credits.

Salary sacrifice and income related benefits:

• Income Support or Jobseeker’s Allowance (JSA), it’s advisable to reach out to your local social security or Jobseeker Plus office for further information.
• Housing Benefit and/or Council Tax Benefit, you should get in touch with your Local Authority.

Effects on mortgage and other credit applications:

Banks and other money lenders typically evaluate your gross income to establish your borrowing capacity.

If you engage in salary sacrifice, this reduces your gross income and may subsequently affect the amount a lender is prepared to offer you.

This issue is particularly important when applying for a mortgage when a primary factor for borrowing is affordability based on your household income and expenses.

Can I claim higher rate pension tax relief on a sacrifice scheme?

Higher and additional rate taxpayers benefit from extra tax relief on their pension contributions which has to be claimed back from HMRC usually through completing a self assessment tax return.

The mechanism of tax relief differs between a salary sacrifice arrangement and a standard workplace pension.

Through a salary sacrifice plan the portion of your income deducted for your pension contributions isn’t taxed which means making a claim for an extra 20% higher rate tax relief isn’t necessary.

Pension salary exchange benefits for employers

A salary sacrifice pension scheme doesn’t just have upsides for employees it has a few advantages for employers too including:

Decreased national insurance payments: By lowering their taxable income, employers can reduce the amount they are required to pay in national insurance contributions.

This gives them the option to either increase their net profits or reinvest the saved money back into the business or their employees pension scheme.

As the number of employees increases, the savings also increase and this can assist companies in reducing their national insurance outlay.

Businesses with a staff of 50 people with a standard salary of £50,000 would have the potential to save a significant amount of money, amounting to around £17,250 annually in the 24/2025 tax year.

Recruiting and retaining staff: A pension plan through salary exchange can be a valuable addition to an employers benefits package.

Being able to offer a salary exchange that increases take home pay and potentially pension contributions is crucial for attracting and keeping high performing employees.