Salary sacrifice pension: how it works
A salary sacrifice pension arrangement lets an employer and an employee pay less Class 1 National Insurance by exchanging part of gross pay for an employer pension contribution [1]. From 6 April 2029, the amount exempt from National Insurance through this route will be capped at £2,000 a year, a change announced at the Autumn Budget 2025 [2].
The government estimates that around 56% of employees making typical pension contributions through salary sacrifice will be unaffected by the cap, because their contributions already sit below £2,000 [2]. Higher earners and those making larger contributions will pay National Insurance on the excess for the first time.
This article explains what salary sacrifice is, how the tax and National Insurance saving arises, the National Minimum Wage floor that limits it, the knock-on effects on statutory pay, and the reform that reshapes the arrangement from April 2029.
Key takeaways
- Salary sacrifice swaps gross salary for an employer pension contribution through a contract change.
- The employer saves National Insurance at 15% and the employee saves at 8% on the sacrificed amount.
- Income tax relief on pension contributions is unchanged by salary sacrifice.
- A sacrifice cannot reduce cash pay below the National Minimum Wage.
- From 6 April 2029, only the first £2,000 sacrificed each year stays free of National Insurance.
- Sacrifice can lower average weekly earnings and reduce statutory maternity pay.
What salary sacrifice actually is
A salary sacrifice arrangement is an agreement to reduce an employee's entitlement to cash pay, usually in return for a non-cash benefit, and it is set up by changing the terms of the employment contract [3]. In a pension context, the employee gives up an agreed slice of gross salary and the employer pays an equivalent amount into the pension scheme instead [1].
The distinction that matters is that the sacrificed pay never reaches the employee as earnings. Because National Insurance is charged on earnings, reducing the cash salary reduces the National Insurance base for both parties [1]. This is why the arrangement is sometimes branded a smart pension or smart scheme in payroll systems [4].
The contract has to change
Salary sacrifice only works if the reduction in cash pay is a genuine variation of the employment contract, not a deduction from pay [5]. The contract must be clear on what the cash and non-cash entitlements are at any given time, and it must be altered each time an employee opts in or out [6].
Payroll must then reflect the reduced cash salary correctly, running PAYE on the lower figure while recording the employer pension contribution separately [5]. Getting the payslip presentation right is part of the compliance test, which is one reason employers lean on HMRC-recognised payroll software rather than adjusting figures by hand [6].
How the saving works
The saving comes almost entirely from National Insurance, because income tax relief on pension contributions is available whether or not salary sacrifice is used [7]. What salary sacrifice adds is the removal of National Insurance on the sacrificed amount for both the employer and the employee [1].
For the 2026-27 tax year, the employer pays National Insurance at 15% on earnings above the Secondary Threshold of £5,000 a year, while the employee pays 8% between the Primary Threshold and the Upper Earnings Limit (gov.uk). The table below shows the effect of sacrificing £2,000 of salary for an employee earning comfortably within the main band.
| Party | Rate on sacrificed pay | Saving on £2,000 sacrificed |
|---|---|---|
| Employer | 15% | £300 |
| Employee | 8% | £160 |
| Combined National Insurance saving | n/a | £460 |
The employer saving is often the larger of the two, and some employers pass part of it back into the employee's pension to make the arrangement more attractive [8]. Accountants modelling this across multiple employers typically use payroll bureau software to show each client the net cost after the employer National Insurance saving [8].
The National Minimum Wage floor
The single hardest limit on salary sacrifice is the National Minimum Wage. A sacrifice must never reduce an employee's cash earnings below the National Minimum Wage for the hours worked in any pay reference period [9]. Unlike an ordinary deduction, sacrificed pay reduces the earnings that count towards the minimum wage, so the check has to be applied to the reduced figure [9].
Salary sacrifice is one of the more common causes of minimum wage underpayment, precisely because employers forget to re-run the check when hours rise or the sacrifice is fixed as a cash sum [9]. Employers offering the arrangement therefore tend to cap it so that lower-paid staff cannot sacrifice into a breach [8]. Software that runs payroll for SMEs can enforce the floor automatically at each payrun.
The knock-on effects to weigh
Reducing cash pay has consequences beyond National Insurance, and these are where employees are most often caught out. Because several statutory entitlements are calculated on earnings that count for National Insurance, a lower salary can quietly reduce them [10].
Statutory pay and average weekly earnings
If a salary sacrifice arrangement runs during the period used to work out Statutory Maternity Pay, the average weekly earnings calculation is based on the reduced, post-sacrifice figure [10]. This can lower the amount of Statutory Maternity Pay, or in some cases remove entitlement entirely where earnings fall below the Lower Earnings Limit [10].
There is an important safeguard in the other direction. Once Statutory Maternity Pay is in payment, it cannot itself be sacrificed, and the employer must pay it in full [10]. The reduction bites at the calculation stage, not during the maternity pay period itself [10].
Benefits, borrowing and state pension
Salary sacrifice can also affect earnings-related benefits such as Maternity Allowance and the earnings used to assess certain state entitlements [11]. The amount received may be lower, or the entitlement may be lost, because the assessment looks at the reduced cash pay [11].
Lenders also look at contractual salary, so a sustained sacrifice can reduce the figure a mortgage provider uses [8]. Employers can mitigate several of these effects by basing pay rises, overtime and other calculations on the notional pre-sacrifice salary, provided the approach is made clear to the employee [5].
The £2,000 cap from 6 April 2029
The largest change to salary sacrifice in years takes effect on 6 April 2029. From that date, earnings given up under a salary sacrifice pension arrangement above a £2,000 annual limit will be subject to both primary and secondary Class 1 National Insurance [12]. Employees can still sacrifice more than £2,000, but the excess loses its National Insurance advantage [12].
Income tax relief is untouched, so contributions made by salary sacrifice remain exempt from income tax in the usual way [2]. The government estimates that among employees affected by the cap, the average additional employee National Insurance liability will be around £84 in the first year, 2029 to 2030 [2].
| Feature | Position before 6 April 2029 | Position from 6 April 2029 |
|---|---|---|
| National Insurance on sacrificed pay | Fully exempt | Exempt up to £2,000, then charged |
| Income tax relief | Available | Unchanged |
| Ability to sacrifice above the limit | Yes | Yes, but National Insurance applies to the excess |
HMRC has said it will engage with employers on the design and operability of the cap before legislating in a National Insurance Bill, so payroll systems will need updating ahead of the start date [12]. An HMRC-recognised payroll API that tracks the running annual total is the cleanest way to apply the cap correctly once it is live.
Salary sacrifice and auto-enrolment
Salary sacrifice can sit alongside auto-enrolment, but the two must not be entangled. An employer may ask an eligible jobholder whether they want a salary sacrifice arrangement, but active membership of the pension scheme cannot be made conditional on agreeing to it [13].
Where a defined contribution scheme is used, the qualifying earnings that meet the auto-enrolment minimum are measured on the post-sacrifice salary [13]. To avoid disadvantaging staff, many employers calculate contributions on a notional pre-sacrifice figure instead [13]. The interaction with the wider duty is covered in the Moonworkers guide to auto-enrolment explained.
Conclusion
Salary sacrifice remains one of the few arrangements that reduces payroll cost for the employer and take-home tax for the employee at the same time, with the saving concentrated in National Insurance rather than income tax. The mechanics are settled: a genuine contract change, a reduced cash salary, and a National Minimum Wage floor that has to be checked every pay period.
The April 2029 cap does not end the arrangement, but it does change the arithmetic for higher contributors and puts a premium on payroll that can track the £2,000 running total across a tax year. Employers weighing the arrangement now should factor in both the immediate National Insurance saving and the effect a lower cash salary has on statutory pay and future entitlements.
Frequently asked questions
Does salary sacrifice reduce the tax relief on my pension?
No. Income tax relief on pension contributions is available regardless of whether salary sacrifice is used, and the April 2029 reform leaves income tax relief unchanged [2]. What salary sacrifice adds on top is the National Insurance saving on the sacrificed amount for both the employer and the employee [1].
Can salary sacrifice take my pay below the minimum wage?
No. A salary sacrifice arrangement must not reduce an employee's cash earnings below the National Minimum Wage for the hours worked in any pay reference period [9]. Employers are expected to cap the sacrifice so that lower-paid staff cannot fall below the floor, and the check must be re-run each payrun [9].
Will salary sacrifice affect my maternity pay?
It can. If the arrangement runs during the period used to work out Statutory Maternity Pay, the calculation uses the reduced post-sacrifice earnings, which can lower the payment or remove entitlement if earnings fall below the Lower Earnings Limit [10]. Once maternity pay is in payment, though, it must be paid in full and cannot itself be sacrificed [10].
What changes for salary sacrifice pensions in April 2029?
From 6 April 2029, only the first £2,000 of pension contributions made through salary sacrifice each tax year will be exempt from National Insurance, with the excess subject to primary and secondary Class 1 National Insurance [12]. Income tax relief is unaffected, and the government expects most typical contributors to be below the cap [2].
