What is salary sacrifice and how does it work?
Salary sacrifice is when your employee gives up part of their salary, and, in return, you provide a non-cash benefit, like a pension contribution. A salary sacrifice agreement means you and your employees pay less National Insurance contributions. It’s important to let your employees know what salary sacrifice is and how it works.
What is a salary sacrifice pension arrangement?
Salary sacrifice, also known as ‘salary exchange’, is an arrangement with you and your employees in which you agree to reduce your employee’s salary by the amount they want to contribute to their pension. You will then pay this amount each month, plus your contribution, to their pension savings instead.
What are the benefits of salary sacrifice?
A salary sacrifice agreement can benefit both you and your employees in many ways.
It allows you to offer increased benefits for your employees, at no extra cost to you.
Both you and your employees pay less National Insurance (NI) contributions.
You can choose how to reinvest those savings. You may choose pension contributions, cycle-to-work schemes or childcare vouchers.
It allows you to offer increased benefits for your employees, at no extra cost to you.
See how much your business could save with salary sacrifice
You can choose to pass on all or some of the savings into your employees pension savings, or alternatively you can decide to retain it for the benefit of your 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 you choose to offer a pension salary sacrifice to your employees, here’s how it would work.
You reduce your employee’s salary by the pension contribution they wish to pay.
The NI contributions paid each month will be calculated on the employee’s reduced salary figure.
The total regular amount paid into their 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 you should consider.
There are two main tax arrangements when it comes to collecting salary sacrifice and pension contributions. You’ll need to find out whether your own payroll software and your 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.
Your payroll provider will need to display the salary sacrifice correctly on payslips - you can choose to show either your employee’s contribution percentage (EE) or both employee and employer contribution percentage (EE and ER).
Your 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 your employees, which is a matter of employment law.
How to set up salary sacrifice
There are a few things you need to consider before you set up a salary sacrifice arrangement.
There are a few decisions to make
An important decision when setting up your arrangement is to decide if you will:
- Keep all of your NI contribution savings
- Reinvest all of your NI savings into your employee pension plan
- Do a bit of both - keep some NI savings for you and your business, but also pass some back to your employees
You can set up your salary sacrifice scheme so that some or all of your employees can join.
By doing so, your employees’ final take-home pay will stay above the National Minimum Wage or National Living Wage.
Speak to your employees
You will need to let your employees know that you’re setting up a salary sacrifice arrangement, and give them the option to opt out if they wish.
It’s important you communicate with your employees so that they know what the salary sacrifice agreement really means for them.
Make sure they understand:
- What salary sacrifice means from an employee point of view
- How they can benefit from the agreement
- 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 you engage with your employees and effectively communicate the benefits of salary sacrifice, we’ve created a useful step-by-step guide to integrating salary sacrifice.
Smart Pension does not offer financial advice. As an employer, you may need to seek specialist legal help on how best to do this, and it’s important to communicate with your employees as you introduce a salary sacrifice arrangement.
Make some updates
You are legally required to update your 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.
You’ll need to make sure your payroll department is aware of the changes so that they can administer the salary sacrifice amounts correctly.
Regulations
By using salary sacrifice you still need to comply with your automatic enrolment duties and ensure that both processes operate correctly.
Set up your salary sacrifice agreement with Smart Pension
When it comes to setting up your salary sacrifice agreement, we aim to make it a smooth and straightforward process.
If you need support, our team will help you out - all you need to do is fill out the online contact form.
