What is salary sacrifice and how could it boost your pension?
Salary sacrifice is a great way to increase your pension pot while lowering your tax bill. But the rules are changing from April 2029. We look at what salary sacrifice is and how to make the most of it now.
Laura Miller
Salary sacrifice can be one of the most effective means of boosting your personal wealth, and it could be worth seriously considering especially if you’re wondering how to spend your annual bonus. But the rules are changing – and this could mean higher earners lose out on up to nearly £900 a year.
The thing that makes salary sacrifice such a powerful savings tool is that it reduces the amount of income tax and National Insurance Contributions (NICs) you pay on your earnings, meaning you get more bang for your buck. Salary sacrifice is most often used to increase pension contributions, but it can be used for a variety of benefits.
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Salary sacrifice schemes could close
The changes will take place from April 2029. So you might want to act soon to take advantage of this generous benefit – especially as two in five (39%) business leaders who currently offer salary or bonus sacrifice schemes say they are less likely to provide the scheme in future because of the reforms, according to new research from the Standard Life Centre for the Future of Retirement.
Salary sacrifice makes sense for employers, as it enables them to offer greater perks to their employees without increasing their salaries. Around a third of private sector employees make use of salary sacrifice arrangements, as well as almost 10% of public sector workers, according to government figures.
Separate research by pension consultancy Barnett Waddingham found nearly two thirds (62%) of workers say they are using salary sacrifice – but a similar number (63%) don’t know it will be capped in 2029, limiting how much can be paid through salary sacrifice without National Insurance being applied.
What is salary sacrifice?
Salary sacrifice (or salary exchange) is a tax-efficient arrangement where an employee agrees to reduce their gross salary in exchange for a non-cash benefit, such as pension contributions, an electric car, or cycle-to-work schemes.
Because the gross salary is lower, both employee and employer pay lower National Insurance contributions, providing immediate tax savings.
“Using salary exchange [for pension contributions] is a way for more money to go into your pension but without any extra cost,” says Clare Moffat, pensions and tax expert at Royal London.
“The benefit is that you pay less income tax and National Insurance. That’s because your salary is reduced before tax and National Insurance is taken off. Your employer also pays less employers’ National Insurance, and they might pass on some or all of this saving to you.”
Higher or additional rate taxpayers who are in a group personal pension get an additional benefit by using salary sacrifice, as they receive all the tax relief rather than having to claim anything above basic rate back from HMRC.
How much could salary sacrifice increase your pension pot?
Workers could boost their pension pots by £41,200 – more than a year’s average salary – by opting into their employers' salary exchange scheme, according to figures from Scottish Widows.
Average salary workers – taking home £37,4301 annually – could increase their take home pay by £150 a year, simply by opting into their employers' salary exchange scheme. If this extra cash is then redirected into their pension pot, alongside the savings the employer makes through reduced National Insurance contributions, their pension savings would be boosted by £528 a year.
For a worker aged 30 and retiring at age 67, and assuming 5% investment growth, this would add £41,200 to their pension savings. Those opting in a decade later, at age 40, would see a £24,500 boost to their pension pot.
What are the changes to salary sacrifice?
Employees who choose to sacrifice salary to receive tax-free childcare or Child Benefit can keep doing so. However, any pension contributions above £2,000 will be subject to employer and employee NICs.
If you are an employee you will not need to contact HMRC. Employers will make the necessary changes so that NICs apply to contributions above £2,000.
The move to curb the attractiveness of pension salary sacrifice has been met with criticism that it will leave employees with smaller pensions.
Someone aged 35 earning £50,000 a year could face a hole in their pension of £22,060 by age 65 under the cap on salary sacrifice, according to analysis by investment platform AJ Bell. This assumes they already have a pension fund of £30,000 and save an overall contribution of 5% personally, with another 3% coming from their employer.
The black hole rises to over £37,000 if they are already a higher earner on £75,000 or even nearly £50,000 for those earning £100,000 a year, based on the same assumptions.
The 2025 salary sacrifice changes do not affect limited company directors. Directors don’t use salary sacrifice, they use employer pension contributions, which are unchanged.
The below table shows the impact on employees’ pay packets and the extra NI bill to employers per year, assuming the employee has agreed to exchange 6% of their total notional salary for a pension contribution, with a 6% employer match.
Total notional salary | Employee contribution (6% sacrificed) | Contribution over cap (not exempt from NI) | Reduction in take home pay | Cost to employer (extra NI) |
£40,000 | £2,400 | £400 | £32 | £60 |
£45,000 | £2,700 | £700 | £56 | £105 |
£50,000 | £3,000 | £1,000 | £80 | £150 |
£55,000 | £4,300 | £1,300 | £26 | £195 |
£60,000 | £3,600 | £1,600 | £32 | £240 |
£65,000 | £3,900 | £1,900 | £38 | £285 |
£70,000 | £4,200 | £2,200 | £44 | £330 |
£75,000 | £4,500 | £2,500 | £50 | £375 |
Source: AJ Bell. Figures based on when the changes come into effect in 2029.
Can you use salary sacrifice on your bonus?
If you’re expecting a bonus, you may be wondering what the best way to spend it is. Some employers offer a bonus exchange scheme, which has similar benefits to salary exchange – with the perk of not reducing your monthly income.
“The key things to consider are immediate financial priorities like debt which you may want to pay off immediately,” Susan Hope, retirement expert at Scottish Widows, told MoneyWeek.
“Secondly, when you might need this cash, for example savings for an emergency or savings goals in the medium-term.
“If it’s money that you don’t need for any of those types of things, using salary exchange to put it into your pension could help not only boost your pot, but for higher earners it could also help when it comes to tax, childcare benefit and personal allowance.”
For a basic rate taxpayer, paying directly into a pension using salary exchange could change a £5,000 bonus into a £6,090 pension contribution in the 2024/25 tax year, or a £6,150 contribution from 2025/26, once the reductions in employer and employee NICs are taken into account.
