What Is Salary Sacrifice Pension? How It Reduces Your Tax Bill

How salary sacrifice works

Under a salary sacrifice arrangement, you agree with your employer to reduce your gross salary by the amount of your pension contribution. Instead of paying pension contributions from your net pay, your employer pays both their contribution and yours directly to the pension scheme before tax is calculated.

Because your gross salary is lower, you pay income tax and employee National Insurance on a smaller amount. The effective cost of your pension contribution is therefore lower than its face value — HMRC is effectively subsidising part of it through the tax and NI you do not pay.

For a basic rate taxpayer in 2025/26, a £100 pension contribution via salary sacrifice costs roughly £68 in reduced net pay. For a higher rate taxpayer, the cost drops to around £58, because both higher-rate income tax and NI are saved.

• Pension contribution comes off gross pay before tax and NI are calculated.
• Basic rate taxpayer saves 20% tax + 8% NI = 28% effective discount.
• Higher rate taxpayer saves 40% tax + 2% NI = 42% effective discount.
• Your employer also saves on their NI contribution — some pass this saving back to you.

Salary sacrifice vs standard pension contributions

A standard (relief at source) pension contribution is taken from your net pay, and the pension provider claims basic rate tax relief from HMRC and adds it to your pot. Higher rate taxpayers need to claim additional relief through self-assessment. The net cost is similar to salary sacrifice for basic rate taxpayers, but higher rate taxpayers get the full relief more efficiently through salary sacrifice.

The key difference is that salary sacrifice also saves employee National Insurance, which the standard relief method does not. For someone paying 8% NI on a contribution, salary sacrifice delivers a meaningful additional saving that standard contributions miss.

Not all employers offer salary sacrifice. If yours does not, a standard personal contribution still gets income tax relief, just not the NI saving.

• Salary sacrifice: saves income tax AND employee NI.
• Standard contribution: saves income tax only (via relief at source or self-assessment).
• Both methods eventually get money into the pension at similar tax-inclusive cost, but salary sacrifice is generally more efficient.

Things to check before increasing salary sacrifice

Salary sacrifice reduces your contractual gross salary, which can affect borrowing capacity. Mortgage lenders typically use your pre-sacrifice gross for affordability calculations, but some lenders may use the lower contractual salary. Check with a broker before making large changes if you plan to apply for a mortgage soon.

State benefit entitlements and statutory payments (sick pay, maternity pay, redundancy) can also be calculated on the post-sacrifice gross in some cases. If your salary falls close to minimum wage boundaries, your employer may not be able to implement sacrifice. Review your contract terms.

Annual pension contribution limits (£60,000 for 2025/26, or 100% of earnings if lower) apply to all contributions regardless of method. If your employer also contributes, ensure combined contributions stay within the annual allowance.

• Check with your mortgage broker before large changes.
• Statutory payments may use post-sacrifice salary.
• Annual allowance limit applies across employer + employee contributions.
• Cannot reduce contractual salary below National Minimum Wage.