Salary sacrifice

Introduction

This briefing sets out the points to consider when using salary sacrifice to pay contributions to pensions, including the criteria to meet, tax considerations and other important issues.
 

Core considerations

• Salary sacrifice is where an employee gives up part of their salary or bonus before it is paid to them in return for their employer paying additional employer contributions.
• The amount sacrificed by the employee is not chargeable to income tax or national insurance contributions (NICs) because it is given up before it is received. By contributing this way all tax relief is received immediately.
• From April 2029 any sacrifice in excess of £2,000 will be liable to employee and employer NICs.
• The amount of an employee’s salary or bonus is reduced by the amount sacrificed which means it can have an impact for anything that is calculated based on the amount of an individual’s salary/bonus received.    
• However, employers can record a notional salary ignoring the amount sacrificed, which can be used in certain calculations to remove the impact of this.  
• For salary sacrifice to be effective it must meet the criteria set down by HMRC. 

Contents 

• Salary sacrifice 
• HMRC requirements 
• Notional or reference salary 
• Other issues to consider
• Passing employer savings to employees
• Example - salary sacrifice in practice

Salary sacrifice

A salary sacrifice (or salary exchange) arrangement occurs when an employee agrees to give up part of their contractual cash salary in return for a non-cash benefit provided by the employer—commonly an additional employer pension contribution. This is achieved by formally varying the employee’s terms and conditions of employment to reflect the reduced cash pay and the agreed benefit.

If the arrangement meets HMRC conditions:

• The sacrificed amount is not treated as earnings for income tax or employee’s or employer’s national insurance contributions (NICs).
• The employer’s contribution to a registered pension scheme is exempt from tax and NICs.

If conditions are not met, then the original cash salary remains taxable and subject to NICs.

April 2029

From April 2029, salary sacrifice for increased employer pension contributions in excess of £2,000 will be subject to both employee and employer NICs. This means there will only be NICs savings on the first £2,000 sacrificed under such an arrangement.

Contractual employer pension contributions will remain exempt from NICs.

HMRC requirements

For a salary sacrifice arrangement to be effective for tax purposes, two key conditions must be met:

1. Timing of the Variation
   
   The employee must give up the right to the cash remuneration before it is treated as received for employment income tax purposes.

For most employees, this means the change must occur before the earlier of:

• The date the payment is made, or
• The date the employee becomes entitled to the payment.

For company directors, additional considerations apply:

• When the remuneration is credited in the company’s accounts or records, and
• The accounting period to which it relates.
   

Bonuses can also be sacrificed, provided the agreement is made before the bonus is treated as received for tax purposes.

2. Contractual Change

There must be a revised contractual agreement confirming the employee’s entitlement to lower cash pay and the agreed benefit. This can be achieved by:

• Issuing a formal letter or pro-forma amendment attached to the employee’s contract,
• Rewriting the contract in whole or in part, or
• Communicating proposed changes and obtaining employee agreement before implementation

HMRC guidance on salary sacrifice is set out in the Employment Income Manual (EIM42700).

Important Compliance Points:

• A salary sacrifice arrangement must not reduce an employee’s cash earnings below the National Minimum Wage or National Living Wage.
• Employers should retain clear documentation of the agreement and timing to demonstrate compliance with HMRC rules.
   

Notional or reference salary

When an employee enters into a salary sacrifice arrangement, their contractual cash salary is reduced in exchange for a non-cash benefit (e.g., employer pension contributions). However, many employers choose to retain a record of the pre-sacrifice salary level, known as the notional salary.

The notional salary represents the employee’s original pay before the sacrifice and is used for reference purposes only. It does not affect the tax or NIC treatment of the arrangement, provided the employment contract has been properly varied to reflect the reduced cash pay.
 

Why employers use notional salary

Maintaining a notional salary can be valuable for several practical and administrative reasons:

1. Pay review and Increases
   Employers often base annual pay reviews or percentage increases on the notional salary rather than the reduced cash salary. This ensures fairness and consistency in reward structures.
    
2. Overtime and Shift Premiums
   Overtime rates or shift allowances may be calculated using the notional salary to avoid disadvantaging employees who have sacrificed part of their pay.
    
3. Holiday and Sick Pay Entitlements
   Statutory and contractual entitlements for holiday pay, sick pay, and other benefits can be based on the notional salary to maintain parity with employees who have not entered into salary sacrifice.
    

Other issues to consider

Entering into a salary sacrifice arrangement reduces contractual cash earnings, which can have several potential consequences:

Mortgage and Credit Applications
Lenders typically assess affordability based on contractual salary rather than any notional salary retained for internal purposes. As a result, a lower contractual salary may reduce the maximum mortgage or loan available—even if the employer provides a notional salary figure.

Health Insurance and Other Salary-Based Benefits
Individual health insurance cover may be affected if premiums or benefit levels are calculated using contractual salary. The impact depends on the formula used by the provider and whether the employer chooses to base cover on notional or actual salary.

Salary-related benefits such as group life assurance or critical illness cover may also be impacted if the employer uses actual salary rather than notional salary for benefit calculations.

Pension Benefits

• Defined Benefit Schemes: A lower contractual salary could reduce pensionable earnings, leading to lower future benefits.

• Money Purchase Schemes: Employer contributions may decrease if they are calculated as a percentage of contractual salary rather than notional salary. The effect will depend on scheme rules and employer policy.

Impact on State Benefits

Salary sacrifice reduces National Insurance contributions, which can affect entitlement to certain state benefits. Examples include:

• State Pension
• Statutory Sick Pay
• Earnings-related benefits such as Statutory Maternity Pay
   

Passing employer savings to employees

Under a salary sacrifice agreement the employer also saves NICs on the reduced salary, creating an opportunity to enhance the overall value of the arrangement. Many employers choose to share their NICs savings with employees by:

• Adding the employer’s NICs savings as an extra pension contribution, boosting the employee’s retirement fund.
• Communicating this as part of the total reward package, reinforcing the value of salary sacrifice beyond tax efficiency.

For example:

• If an employee sacrifices £2,000 of salary for pension contributions, the employer saves 15% NICs (£300).
• The employer could agree to pay this £300 into the pension alongside the sacrificed amount, increasing the total contribution to £2,300.
   

Example - salary sacrifice in practice

Robert is an employee earning £75,000 per annum and is a member of his employer’s group personal pension plan. He pays 8% of his gross salary into the scheme and this is matched by his employer. Robert has spoken to his employer and is looking to exchange 8% of his salary to receive additional employer contributions instead of making gross personal contributions.

Salary sacrifice will increase his take home salary as he will pay national insurance on a salary that is £6,000 lower. Robert’s employer is also willing to pay the employer’s national insurance savings as an additional contribution for Robert (this is not always the case). Robert’s employer pension contribution will continue to be based on his notional salary, pre salary sacrifice. As an additional option Robert is also considering maintaining his current take home pay and increasing his pension contribution further.

The details are based on 2026/27 income tax and National Insurance rates set out below.: 

Robert can benefit from an uplift of £120 to his take home pay and have an increase of £900 to his pension contribution through salary sacrifice.

Using the alternative approach he can maintain his take home pay, and have an increase of £1,137.93 to his pension contribution.

The employer could agree to the salary sacrifice without passing on the national insurance savings, in which case both the employer and Robert end up in a slightly better overall position.

Income tax and National Insurance is calculated as follows (using current position before salary sacrifice as the example): 

Employer NI

£75,000 salary (NI savings with salary sacrifice).

Salary above secondary threshold of £5,000 = £70,000

NI at 15.0% = £10,500