What are salary sacrifice pensions?

A salary sacrifice pension can help boost your retirement pot. We explain what it is and how it works

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A salary sacrifice pension is a tax-efficient way to make contributions towards your retirement savings - we explain how it works and how it can boost your pension

Making regular pension contributions is the best way you can save for retirement. But, how you do it can make a big difference to the amount you pay in and how much it takes away from your monthly income. 

One way to boost your workplace pension contributions at little cost to yourself can be with salary sacrifice. 

Here’s what you need to know.

What is a salary sacrifice pension?

Some employers offer a range of salary sacrifice schemes to employees. These allow you, the employee, to swap part of your salary for a benefit. This could be a company car, a season ticket for your commute or increased pension contributions.

Using salary sacrifice for your pension means you take a salary cut and your employer pays the same amount into your pension. This saves you money on national insurance contributions and income tax, giving your take home pay a boost. Your employer will also save on national insurance contributions, which they may add to your pension pot, meaning your pension savings will also get a boost.

All this means you make a bigger pension contribution without losing any extra money.

What are the benefits of salary sacrifice pensions?

The big benefit of making pension contributions via salary sacrifice is you can boost your take home pay without sacrificing how much goes into your pension.

For example, if you earn £30,000 a year - then in line with auto-enrolment, you pay 4% of your salary into your pension, you get 1% tax relief and 3% is paid by your employer. This means you are paying £1,200, your employer is adding £900, plus there’s £300 tax relief. That adds up to a total pension contribution of £2,400.

If you opted for a salary sacrifice pension you could cut your annual salary to £28,202. This reflects the fact your employer is paying your £1,200 pension contribution and you are paying £360 less income tax and £238 less national insurance.

Salary sacrifice also reduces the amount of national insurance your employer is paying and, in many cases, they will pay that difference into your pension. In our example the employer saves £270 on national insurance which they add to your pension.

Your take home pay after tax wouldn’t change, but you would have increased your annual pension contribution to £2,968.

Salary Sacrifice Pension Example

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Header Cell - Column 0 Before Salary SacrificeAfter Salary Sacrifice
Employee salary£30,000£28,202
Annual income tax£3,486£3,126
National Insurance£2,397£2,159
Overall pension contribution (including employee contribution, employer contribution and tax relief)£2,400£2,968
Take home pay£22,917£22,917

Source: Hargreaves Lansdown

Salary sacrifice is also a great way to lower your taxable income in order to avoid going into a higher income tax bracket. Let’s say you are getting a pay rise that would take your annual income over £50,271. That would push you into the higher bracket and your income tax on what you earn over that amount would double to 40%. However, if you opt to pay part of your pay rise into your pension via salary sacrifice you could keep your annual pay under the threshold and avoid paying 40% tax.

Also, if you are a higher or additional rate taxpayer it can be simpler as you won’t have to claim tax relief via self-assessment. With standard pension contributions the government automatically adds 20% to your contribution to reflect the basic rate of income tax that has been paid. But higher and additional rate taxpayers have to claim the extra tax they have paid back once a year from HMRC via self-assessment. Paying via salary sacrifice would avoid that as no income tax has been paid on the money going into the pension.

When is salary sacrifice pensions a bad idea

Salary sacrifice pensions aren’t always right for everyone. Giving up part of your salary can have a knock-on effect on other benefits. For example, it could mean your sick pay, and maternity pay are lower. It could also affect any life cover your employer offers, as this is usually a multiple of your salary.

Lowering your annual salary will also affect how much you can borrow if you want to get a mortgage or remortgage as lenders often offer you a multiple of your pay.

Finally, salary sacrifice can be a great way to boost your workplace pension, but it could have an adverse effect on your state pension. That’s because the portion of your salary that you sacrifice doesn’t qualify for national insurance contributions. Your state pension is calculated on the basis of how many national insurance contributions you receive. This could mean your reduced national insurance contributions leave you with a smaller state pension.

How can I get a salary sacrifice pension?

If you are interested in a salary sacrifice pension, then you need to speak to your employer. While all employers have to offer a workplace pension, they don’t have to offer salary sacrifice schemes. So, you need to check if your employer offers a salary sacrifice pensions scheme.

Salary sacrifice schemes can be offered for both defined contribution and defined benefit pension schemes. So, it is worth checking regardless of what type of pension you have.

Is salary sacrifice pension better?

“Salary sacrifice is a great way to really boost your pension contributions without affecting your take home pay,” says Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown. “Over time those extra contributions really mount up and make a huge difference to how much you end up with in retirement.

“However, there are things you need to look out for. As salary sacrifice decreases your salary this means your entitlement to other employer benefits such as life insurance may also be reduced. It will also affect how much you can borrow for things like mortgages. Lower salaries may also affect how much you receive from things like maternity pay as well.”

Ruth Jackson-Kirby
Personal finance journalist

Ruth is a personal finance journalist with 17 years’ experience writing about everything from pensions to pet insurance. Ruth started her career as a staff writer for MoneyWeek and she continues to edit their personal finance section. Ruth also writes for numerous national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping. Ruth is passionate about ethical investing and encouraging people to take control of their finances and not be put off by jargon.