Penfold explains how salary sacrifice pensions work

Salary sacrifice pensions are a tax efficient way for employers and employees to pay into a workplace pension scheme. They can help employees increase their take home pay and help employers lower their National Insurance contributions.

What is salary sacrifice?

Salary sacrifice is a government backed scheme to help employers and their workers save on tax. An employee agrees, with their employer, to give up part of their salary in exchange for non-cash benefits. The benefits are not subject to income tax or National Insurance contributions (NICs) so their taxable salary is reduced.

What is a salary sacrifice pension?

In a salary sacrifice arrangement, employees agree to give up a part of their earnings, reducing their overall salaries. The employer agrees to pay these ‘sacrificed’ earnings directly into employees’ workplace pensions. By reducing salaries, both employees and employers are subject to lower National Insurance contributions. This means they pay less tax and get to keep more of what they earn overall.

How does salary sacrifice work?

Let’s say you offer a salary sacrifice pension to your employees and one of your employees earns £50,000 a year. The employee decides to sacrifice £2,500 of their salary to their pension. The employer contributes this £2,500 to their pension fund directly. The employee would not pay tax on the pension contribution, therefore their taxable income would be reduced to £47,500. This can lower the employee’s tax bill by hundreds of pounds each year.

Salary sacrifice example

Here’s an example of how a salary sacrifice scheme works for an employee who earns £50,000 a year.

Before salary sacrifice:

The employee contributes 5%, £2,500, of their earnings into their workplace pension. The employer contributes a further 3%, £1,500. Therefore total pension contributions are £4,000. The employee’s PAYE and National Insurance tax bill is £9,980.40. After pension contributions and tax deductions the employee’s net annual pay is £37,519.60. The employer’s National Insurance tax bill is £5,644.20.

After salary sacrifice:

The employee earns £47,500 a year, sacrificing £2,500, or 5%, of their salary. The employer contributes the £2,500 employee sacrifice as well as the previous £1,500 employer contribution. Therefore total pension contributions remain £4,000. The employee’s PAYE and National Insurance tax bill is £9,780.40. After pension contributions and tax deductions the employee’s net annual pay is £37,719.60, that’s £200 more. The employer’s National Insurance tax bill is £5,299.20, that’s £345 less.

Employer National Insurance savings

The savings scale up with employee headcount and can help businesses save money on their National Insurance bill. Based on an average salary of £50,000 with each employee sacrificing the legal minimum contribution of 5% the savings are: Businesses with 50 employees could save £17,250 each year. Businesses with 100 employees could save £34,500 each year. Businesses with 250 employees could save £86,250 each year.

What are the employer benefits?

There are many benefits to offering a salary sacrifice pension, including: reduced National Insurance contributions, attracting and retaining the best talent, and demonstrating a commitment to employee financial wellbeing.

What are the employee benefits?

Offering a salary sacrifice pension can provide significant benefits for employees as well. Some of the benefits include increased take home pay and greater pension contributions.

What are the drawbacks?

Salary sacrifice can have an impact on anything that is linked to an employee’s salary. Here are a few things that may affect your decision to switch to a salary sacrifice scheme. Restrictions on low income earners, effects on salary-based benefits such as life insurance or loan applications, and potential maternity pay reduction.

Setting up a salary sacrifice pension

Setting up a salary sacrifice pension can be straightforward if your existing provider already provides the option. Employers should contact their payroll or pension provider, get employee permission, and manage opt-outs for employees that don’t agree to salary sacrifice.

How Penfold can help

Offering a pension with salary sacrifice can provide significant benefits to both employers and employees. Penfold’s tech-first workplace pension makes it easy for employers to set up or convert to a salary sacrifice pension. We’ll help you save money with tax efficient pension contributions at your business.

Find out more at getpenfold.com.

Meet the Penfold team at Accountex Summit Manchester on stand E6, taking place at Manchester Central on 23 September 2025.  

For further information, please visit www.accountexmanchester.com.

Book your free ticket here.

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