The benefit of using salary sacrifice

The double blow of an increase in the rate of National Insurance Contributions (NICs) and the lowering of the threshold at which it is payable, has brought a lot of concern around increasing costs for businesses. The increase in employer NICs comes into effect in April 2025 and has faced criticism from companies worrying about the long-term effects on job creation and economic growth. However, there remains some opportunity to mitigate this increased cost by opting into salary sacrifice for employees to enhance their workplace pension.

Though not a new concept, salary sacrifice is one of the few opportunities employers have to reduce the direct cost of employing people. 

What is salary sacrifice?

Salary sacrifice, or salary exchange, is an arrangement whereby an employee gives up their right to receive an amount of salary in exchange for their employer providing them with some form of benefit. The arrangement can be used for any employee benefit, but most do not yield the tax or NIC savings of employee pension contributions.

Whilst it sounds like a simple concept, the requirements go beyond simply deducting an amount from an employee’s taxable pay and calling it salary sacrifice on a payslip. The key element is ‘giving up the right to receive cash and instead be provided with a benefit’. Employment contracts give employees the legal right to receive an amount of money in exchange for their services. For a salary sacrifice arrangement to be effective, the agreement between the employee and the employer must override, or change the right as stated in the employment contract. The agreement must be clear and legally binding and enact a change to the contractual entitlement, to receive a certain salary and replace it with an entitlement to receive a reduced salary, plus a benefit in exchange for their services.

Paperwork is key! The agreement with the employee must be in writing, stating that they are giving up the right to the cash. Simply stating something will be a salary sacrifice on a payslip is not sufficient to meet HMRC’s definition.

The benefit for the employer

When using salary sacrifice for employee pension contributions, an employee agrees to give up either a fixed amount or a % of their salary each month in exchange for a larger contribution to their employer pension pot. 

If properly implemented, salary sacrifice moves the amount the employee contributes to their pension, from being a post-tax deduction to being a pre-tax reduction in earnings. As employer pension contributions are exempt from NICs, there is a saving for both the employee and the employer.  

However, the marginal rates of employee NIC, payable at 8% or 2%, it is the employer saving at 13.8%, which is soon to rise to 15%, that is causing companies to consider available options.

Below is an example demonstrating the saving for a single employee earning £50,000 and making a mandatory 5% contribution to their workplace pension each year. The employee’s 5% is funded by a 4% post tax deduction from the employee and 1% basic rate tax relief, which the pension fund claims directly from the government.

	Without salary sacrifice	Using salary sacrifice
Salary	£50,000	£47,500
Employee pension contribution at 4% (from net pay)	£2,000	None
Basic rate tax relief claimed by pension	£500	£0 (only due on employee contributions)
Employer pension contributions at 3%	£1,500	£4,000
Total payment to pension fund	£4,000	£4,000
Employee PAYE tax and NIC	£10,480	£9,780
Take home pay	£37,520	£37,720
Employer NIC liability (13.8%)	£5,644	£5,299

For the employee, there is a £200 per year increase in their take-home pay by using salary sacrifice. A nice saving but nothing to write home about.

However, for the employer, there is a reduction in their NIC liability for this single employee of £345 per year, at the rate of 13.8%. The saving will be in the region of £375 per year for this employee, once the rate increases to 15% in April 2025.

The immediate cost of employing this £50,000 salaried individual will increase overnight on April 5th 2025 by around £1,080, if salary sacrifice is not being used for employee pension contributions.

Whilst a £375 saving per year still doesn’t sound a lot, this is for just one employee. If the company had 50 employees on £50,000 and contributed the same 5% to their pension, the company could save £18,750 per year. 120 employees on this basis, a company could save £45,000 per year, with 200 employees it would save £75,000. As you can see, the numbers quickly become hard to ignore for companies with a fairly modest number of employees.

The benefit for employees

As shown in the example, employees enjoy a slightly increased take-home pay from using salary sacrifice but there are other benefits too.

Most significant is the acceleration of the tax relief employees receive on their pension contributions. To be clear, there is no difference in the tax relief on pension contributions under salary sacrifice, or when employees contribute directly. There is however a significant difference in when and how that tax relief is given.

Rather than tax relief being given via a basic rate top-up to the pension by the government and then higher rate taxpayers needing to claim the additional relief via self-assessment or via a refund claim, (which may not be repaid until well after the end of the tax year in which the contribution was made), the full amount of the tax relief is given when the ‘contribution’ is made.

Using salary sacrifice means that fewer earnings are reported to HMRC, and having the ability to sacrifice earnings into a pension, is a very valuable tool for employees who are at, or approaching thresholds in the tax system. We specifically see an increased use of pension contributions via salary sacrifice by employees at the start of high-income child benefit charges, and the start of personal allowance phase-out.

Drawbacks

Whilst having fewer earnings reported to HMRC is for some a huge benefit, for others this can have a negative impact. The lower reported earnings can impact mortgage applications or benefits from a life insurance policy. Most of the situations where this creates a negative impact, can be overcome by a letter confirming what your salary was before the sacrifice, however this cannot be guaranteed. 

Not universally available

The use of salary sacrifice is unfortunately not available to all employees, particularly those paid below the national minimum wage.

Will you need to issue new employment contracts?

Thankfully, no. There are several ways that an employee’s entitlement to the payment of earnings can be changed without needing to issue new employment contracts.

The most common way that the contractual change is facilitated, is by using an addendum to the employment contract. These can be simple, but at a minimum, should clearly state the following: –

1. The employee agrees to the variation in the terms and conditions of their employment
2. State how much the employee agrees to their monthly salary being reduced by
3. The date that they wish the change to take effect from

The addendum will need to be signed by the employee for the variation to become legally binding, and given the importance of the change in entitlement, we strongly recommend seeking advice from an employment lawyer.

Employee consultation

Pensions are a highly emotive topic for some and a change to the status quo is often met with resistance. In our experience, poor take-up of a salary sacrifice scheme (for pension contributions) is due to poor communication at the outset, and a failure to alleviate employees’ concerns about losing out on tax relief and being worse off as a result of the proposed changes.

Many companies are put off looking at salary sacrifice, by the belief that they require an extortionate amount of work, or that they are very expensive to set up. Neither is particularly true. Yes, there is some work needed to set up and coordinate with employees and external providers, but an external provider can project manage this on your behalf. With the benefits of the NIC saving being generated immediately, the cost of implementation is often recovered in just a few months (depending on employee take-up).

Salary sacrifice for pension contributions is one of the very few opportunities available to companies to reduce the direct costs of their wage bill. With the sharp and painful increase incoming on April 6th, can your business really afford not to consider if salary sacrifice can work for your employees?