What is salary sacrifice?
Salary sacrifice (sometimes called 'salary exchange') is an arrangement where an employee agrees to reduce their contractual salary. In return, the employer pays the equivalent amount into the employee's pension as an additional employer contribution.
Because pension contributions paid by the employer are not subject to National Insurance, both the employer and employee save money. The employee also benefits from income tax relief on the full contribution.
How the savings work
Example: An employee earning £30,000 sacrifices £100 per month into their pension.
- Without salary sacrifice: Employee pays £100 from net pay. Employer pays employer NI on the £100 (£15 at 15% rate).
- With salary sacrifice: Employee's salary reduces by £100. Employer pays £100 as employer pension contribution. Neither party pays NI on the £100. Employee saves £8 NI per month. Employer saves £15 NI per month.
Over a year, the employer saves £180 in NI per employee on just £100/month of sacrifice. Many employers share some of this saving with employees by increasing the total pension contribution.
Setting up salary sacrifice
Salary sacrifice requires a formal variation to the employment contract. The key requirements are:
- The agreement must be in writing
- It must be agreed before the pay period it applies to (you cannot sacrifice pay retrospectively)
- The employee must genuinely give up the right to the sacrificed salary — it cannot be a sham arrangement
- Employees should be given a clear explanation and time to consider the arrangement
Salary sacrifice must not breach the National Minimum Wage
After the salary sacrifice, the employee's remaining cash pay must not fall below the National Minimum Wage for their age group. If sacrifice would take them below NMW, you must either reduce the sacrifice amount or exclude them from the arrangement.
Check this at each pay period, especially when NMW rates change each April.
Auto-enrolment compliance
Salary sacrifice does not change your auto-enrolment duties. The total employer contribution (including the sacrificed amount) must still meet the minimum 3% on qualifying earnings. In practice, salary sacrifice arrangements usually exceed the minimum because the sacrificed amount is additional to the employer's standard contribution.
Workers can still opt out of auto-enrolment even if they have a salary sacrifice agreement in place. If they opt out, the salary sacrifice arrangement should also end and their original salary should be restored.