What Is Salary Sacrifice and How Does It Work?

Salary sacrifice, also known as salary exchange, allows an employee to give up part of their gross salary in return for a non cash benefit, such as an employer pension contribution. Because the employee’s gross salary is reduced, the arrangement can affect both Income Tax and National Insurance, while employers can potentially reduce their employer National Insurance costs.

Pension contributions are one of the most common uses. Penfold explains that salary sacrifice can increase the amount going into a pension while potentially reducing the employee’s tax and NI liabilities. Its worked example shows how a £1,500 salary sacrifice could increase the pension contribution while reducing NI costs for both parties.

There are, however, important considerations. Salary sacrifice cannot reduce pay below minimum wage or statutory pay entitlements, and it can affect calculations linked to salary, including some benefits, bonuses and mortgage applications.

The article also covers changes introduced following Budget 2025, including reduced National Insurance advantages for pension salary sacrifice from April 2026, while income tax relief remains unaffected.

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