A salary sacrifice (also called salary exchange) is a contractual arrangement where an employee agrees to give up part of their cash salary in exchange for a non-cash benefit provided by the employer. Both parties can save on National Insurance because the benefit is provided instead of salary, reducing the earnings on which NICs are calculated.
How Salary Sacrifice Works
The employee and employer agree to a permanent change to the employment contract. The employee’s contractual salary is reduced, and the employer provides a benefit of equivalent value.
Example: Pension Salary Sacrifice
An employee earning £35,000 sacrifices £1,750 for additional pension contributions. The figures use illustrative rates of 8% employee NIC, 20% income tax and 15% employer NIC on the sacrificed amount:
| Component | Before Sacrifice | After Sacrifice |
|---|---|---|
| Gross salary | £35,000 | £33,250 |
| Employee NIC | £1,794.40 | £1,654.40 |
| Income tax | £4,486.00 | £4,136.00 |
| Employer NIC | £4,500.00 | £4,237.50 |
| Pension contribution | £0 (employee pays separately) | £1,750 (employer pays into pension) |
Employee saves: £140.00 NIC + £350.00 tax = £490 per year
Employer saves: £262.50 employer NIC per year
The pension contribution is made entirely by the employer, so it is exempt from both income tax and NICs.
Common Salary Sacrifice Benefits
Not all benefits work with salary sacrifice. Since April 2017, HMRC restricts the NIC and tax advantages to a limited set of benefits:
| Benefit | Salary Sacrifice Tax/NIC Advantage |
|---|---|
| Pension contributions | Full NIC and income tax saving |
| Childcare vouchers (closed to new entrants) | Full NIC and income tax saving for existing members |
| Cycle to work scheme | Full NIC and income tax saving |
| Ultra-low emission cars (CO2 ≤ 75g/km) | Benefit in kind taxed at low rate; NIC saving |
| Other benefits (e.g. gym, private medical) | No advantage — taxed as if the salary had been received |
For benefits outside the approved list, the employee is taxed on the higher of the salary sacrificed or the taxable value of the benefit. This means there is no tax advantage for most non-approved benefits.
Impact on Other Entitlements
Salary sacrifice reduces the employee’s contractual salary, which can affect entitlements based on earnings:
Statutory Payments
| Entitlement | Impact |
|---|---|
| Statutory Maternity Pay | Based on average weekly earnings — sacrifice could reduce SMP |
| Statutory Paternity Pay | Same as SMP — could be reduced |
| Statutory Sick Pay | Based partly on average weekly earnings from 6 April 2026, so sacrifice could reduce the payment |
| Shared Parental Pay | Based on average weekly earnings |
| Redundancy pay | Based on a week’s pay — sacrifice could reduce the amount |
Other Considerations
- Mortgage applications — lenders may use the reduced salary figure
- State Pension — if sacrifice reduces earnings below the NIC Lower Earnings Limit, it could affect State Pension qualifying years
- Student loan repayments — generally fall when the sacrificed amount reduces pay subject to Class 1 NIC
National Living Wage
The post-sacrifice salary must not fall below the National Living Wage when divided by hours worked. Employers must check this before implementing any sacrifice arrangement.
Setting Up a Salary Sacrifice Scheme
Legal Requirements
- There must be a genuine contractual change — not just a payroll arrangement
- The employment contract must be formally varied
- The employee must agree in writing before the sacrifice takes effect
- The arrangement must be for future earnings only — salary already earned cannot be sacrificed retrospectively
Practical Steps
- Design the scheme — choose which benefits to offer and calculate potential savings
- Communicate to employees — explain the benefits and any impacts on other entitlements
- Obtain written agreement — each employee signs a variation to their contract
- Update payroll — reduce gross salary and set up the benefit provision
- Review regularly — typically annually, with the option for employees to opt in or out at renewal
Opt-Out Windows
Most salary sacrifice schemes include lifestyle events that allow employees to change their participation outside the normal renewal window:
- Marriage or entering a civil partnership
- Birth or adoption of a child
- Partner’s redundancy
- Significant change in circumstances
Salary Sacrifice and Payroll
The sacrifice affects PAYE payroll processing:
- Gross pay is the reduced (post-sacrifice) amount
- Income tax and NICs are calculated on the reduced gross pay
- The sacrificed amount is paid directly by the employer to the benefit provider (e.g. pension scheme)
- The payslip should show both the original salary and the sacrifice deduction
- Report the reduced pay through RTI
Accounting for Salary Sacrifice
Salary sacrifice affects the employer’s accounting records:
| Account | Impact |
|---|---|
| Salary expense | Reduced by the sacrifice amount |
| Employer NIC | Reduced (calculated on lower salary) |
| Benefit cost | Increased (employer pays the benefit) |
| Net effect | Typically a small saving due to NIC reduction |
The overall cost to the employer is usually neutral or slightly beneficial because the NIC saving on the sacrificed salary exceeds any additional cost of providing the benefit.
HMRC Reporting
For benefits provided through salary sacrifice:
- Pension contributions — no additional reporting beyond RTI
- Cycle to work — no P11D reporting while the cycle exemption conditions are met; a later transfer below market value can create a reportable benefit
- Company cars — report the car benefit on P11D
- P60 shows the reduced earnings figure at year-end