Is Salary Sacrifice Right For Me?
Salary sacrifice applies to a number of workplace benefits such as childcare vouchers or cycle-to-work schemes, not just pensions. It's where you give up some of your monthly earnings while your employer puts it towards something else - in this case, pension contributions.
Salary sacrifice is simultaneously an alternative way to save into a pension, cut your income tax, and reduce your National Insurance Contributions (NICs).
You receive a lower salary, but your take-home pay might be the exact same or higher, and extra money is paid into your pension by your employer.
How Does It Work?
Your employer may offer you a salary sacrifice as part of their pension scheme. If so, you can give up part of your salary (your sacrifice), which your employer then pays into your pension, along with their contribution to the scheme.
As you're effectively earning a lower salary, both you and your employer pay lower National Insurance Contributions.
For basic-rate taxpayers
Because your pension contribution comes out of your pre-tax salary, you'll pay less income tax at 20%. You'll also avoid your 12% NI contributions on the amount you sacrifice. This means for every £68 you sacrifice from your pay packet, £100 goes into your pension pot.
For higher or top-rate taxpayers
Read more about Salary Sacrifice for High Earners as the annual allowance is tapered.
Your employer may then choose to pay part or all of their NIC saving into your pension too, although they are not required to.
You can ask your employer to carry out a calculation to show how salary sacrifice would affect your take home pay, and whether or not they will be paying all or some of the NICs they save into your pension pot.
You don't have to go ahead with salary sacrifice if you don’t think it’s right for you.
In the year 2022/23, the annual allowance for tax-free pension savings was £40,000. If you exceed the allowance, then you will be taxed on the amount above the threshold and you will be faced with an annual allowance charge which will probably negate most (if not all) tax relief on the excess above the annual allowance.
Top Tip! If you would like to save towards your retirement but are at risk of going over your annual allowance, put the money into an ISA or invest it instead to make the most of your savings.
Is it right for you?
The key advantage of salary sacrifice can be greater take home pay, as you will be paying lower National Insurance Contributions. You may also benefit from more pension contributions from your employer, if they are giving you some or all the money, they are saving on NICs.
But you need to weigh up disadvantages against this too.
- If your employer is providing you with life insurance, this is usually worked out as a multiple of your salary. Your employer may provide less life cover if you sacrifice some of your salary.
- Your lower salary may affect the amount of money you are able to borrow for a mortgage. Mortgage lenders usually calculate how much you can borrow as a multiple of your salary, although your employer may agree to state your original salary when they supply a mortgage reference.
- Your entitlement to certain State benefits, such as Statutory Maternity Pay (SMP) may be affected. In 2019/20, if your salary sacrifice takes your salary below £118 per week, £512 per month or £6,136 per year, you'll be affected. If that's you — think twice before sacrificing.
If you are in a Defined Benefit pension scheme and you leave the scheme in the first two years, then you may not be able to receive a refund of your contributions (as any salary sacrifice contributions would count as employer contributions. This also applies to trust based Defined Contribution scheme membership started before October 2015.)