What is salary sacrifice and how does it work?
Salary sacrifice is when an employee gives up part of their salary, and, in return, an employer provides a non-cash benefit, like a pension contribution. A salary sacrifice agreement means employers and their employees pay less National Insurance contributions.
What is a salary sacrifice pension arrangement?
Salary sacrifice, also known as ‘salary exchange’, is an arrangement with your client and their employees in which they agree to reduce their employee’s salary by the amount the employee wants to contribute to their pension. They will then pay this amount, plus their contribution, to the employees pension savings instead.
What are the benefits of salary sacrifice?
A salary sacrifice agreement can benefit both employers and their employees in many ways.
It allows employers to offer increased benefits for their employees, at no extra cost to them.
Both employers and employees pay less National Insurance (NI) contributions.
Employers can choose how to reinvest those savings. They may choose to share them with employees or use them to fund other benefits.
It can help increase employee satisfaction and retention.
See how much employers could save with salary sacrifice
Employers can choose to pass on all or some of the savings into their employees pension savings, or alternatively they can decide to retain it for the benefit of their business.
Estimated annual employer National Insurance savings, based on an average salary of £30,000 and 2026/27 employer National Insurance rates (15%).
How does salary sacrifice pension work?
If employers choose to offer a pension salary sacrifice, here’s how it would work.
They reduce their employee’s salary by the pension contribution the employee wishes to pay.
The NI contributions paid each month will be calculated on the employee’s reduced salary figure.
The total regular amount paid into the employee's pension plan will not reduce and may increase at no extra cost, depending on the basis of the arrangement.
The amount exchanged will be added to the employer contribution and result in a new total employer only contribution being paid into the member’s pension.
Important points to consider
Before setting up salary sacrifice, there are a few important points your clients should consider.
There are two main tax arrangements when it comes to how pension contributions are collected. Your clients will need to find out whether their own payroll software and their provider’s systems support a net pay or relief at source (RAS) arrangement.
Admin and HR work will be required to set up the salary sacrifice arrangement.
The employers payroll provider will need to display the salary sacrifice correctly on payslips - your clients can choose to show either the employees contribution percentage (EE) or both employee and employer contribution percentage (EE and ER).
Employees’ pre-tax salaries will reduce, which may impact their entitlement to statutory or salary benefits.
Salary sacrifice will affect the employment terms and conditions for employees, which is a matter of employment law.
How to set up salary sacrifice
There are a few things the employer will need to consider before setting up a salary sacrifice arrangement.
There are a few decisions to make
An important decision when setting up the arrangement is to decide if your client will:
- Keep all of the NI contribution savings
- Reinvest all of the NI savings into their employee pension plan
- Do a bit of both - keep some NI savings for them and their business, but also pass some back to their employees
Employers can set their salary sacrifice scheme up so that some or all employees can join.
By doing so, their employees' final take home pay will stay above the National Minimum Wage or National Living Wage.
Employee engagement
Employers will need to let their employees know that they’re setting up a salary sacrifice arrangement, and give them the option to opt in if they wish. Employees will need information on how the arrangement works and the restrictions around changing their mind if they opt in.
It’s important that your clients communicate with employees so that they know what the salary sacrifice agreement really means.
Make sure employees understand:
- what salary sacrifice means from an employee point of view
- how they can benefit from the agreement
- the implications of the change in their salary on state benefits and their ability to borrow, for example mortgages
- what changes they will see in their Smart Pension account
- when the new changes will go live
- how they can make changes to their pension contribution
To help your clients engage with their employees and effectively communicate the benefits of salary sacrifice, we’ve created a useful step-by-step guide.
Inform their payroll department
Your clients need to make sure their payroll department is aware of the changes so that they can administer the salary sacrifice amounts correctly.
Make some updates
Employers are legally required to update their employees’ contracts and will also need to let HM Revenue & Customs (HMRC) know.
Employees’ payslips need to be updated to reflect the new salary sacrifice arrangement.
Regulations
By using salary sacrifice, employers still need to comply with automatic enrolment duties and ensure that both processes operate correctly.
Set up your client's salary sacrifice agreement with Smart Pension
When it comes to setting up your client's salary sacrifice agreement, we aim to make it a smooth and straightforward process.
If you need support, our team is here to help - simply complete the online contact form to get started.
