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The idea that you should lower your pay to be better off financially sounds like nonsense – but that’s how the government-backed salary sacrifice scheme works.
Salary sacrifice lets you pay for things like insurance policies or gym membership through your company’s payroll, or make extra contributions to your pension, and these salary deductions then reduce how much tax you pay.
It could be especially useful at a time when more people are being pushed into higher bands for income tax – an estimated 70,000 people since April have been dragged into the 40% tax bracket, due to the government’s freeze on thresholds.
In this article, we explain:
Salary sacrifice is a workplace scheme where you give up some of your earnings each month in return for a non-cash benefit.
This deduction reduces your salary and, because your income is lower, you pay less income tax and national insurance.
Employers are happy to offer salary sacrifice to staff as it saves them national insurance contributions too.
The most well-known kind of salary sacrifice is probably the Cycle to Work scheme, where you get a big discount on a bike for commuting, but there are many more options now.
The non-cash benefits that you can get through salary sacrifice include:
But which ones an employer offers – if any – is up to individual company policy. Often larger organisations have a wider range of salary sacrifice options.
If it’s something you would be paying for anyway, such as gym membership, getting it through salary sacrifice can be more financially advantageous than going direct to the provider.
If you want to learn more about your tax contributions, use our income tax calculator to see how much tax you pay each month.
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If your employer offers salary sacrifice, it’s likely they’ll display the range of benefits available on the company’s intranet, on a poster in the office, or you’ll receive information about it when you join.
There might be a specific time of year or enrolment period when you can choose to take up benefits. Other companies let you opt in to salary sacrifice at any point. If you’re not sure what your employer offers, ask HR or a union representative.
Normally what happens is that you decide on salary sacrifice for a specific benefit and you sign up during your employer’s enrolment period.
The employer pays for your perks from your gross pay, which is your salary before tax and national insurance are calculated.
Then they calculate what tax you’re due on this lower salary, and deduct it.
Your payslip will show a deduction for salary sacrifice.
Meanwhile, HR will provide you with details of where you can access your benefit. If it’s something like a vehicle you will be put in touch with the dealer.
If it’s additional pension contributions, they will be set up for you and the money paid in.
You should see the change in income tax and national insurance reflected on your pay slip. In some cases your take-home pay might actually go up.
Your salary sacrifice arrangement can also be changed at any time, should you wish to alter the amount or stop it altogether.
One of the most common ways to take advantage of salary sacrifice is by making additional pension contributions.
Employers have to give staff a pension, with a few exceptions, under a rule called auto-enrolment.
Still, most people need to be putting more into their pensions so they have enough to live on in retirement. But pension contributions can be a big monthly expense. So opting to make those contributions through salary sacrifice can be a savvy way of boosting your retirement pot and, at the same time, reducing your bill for tax and national insurance.
Bear in mind that there’s a limit to how much each person can put into a pension each year, and get tax relief. For most people it’s the equivalent of their annual salary up to £60,000, but it can get complicated with salary sacrifice, especially for higher earners. So it’s best to take proper financial advice before you start.
Calculating salary sacrifice for pensions can be a bit fiddly. However, the following example from the investment company Hargreaves Lansdown, using 2023/24 tax year calculations, shows how making your pension contributions in this way can be more tax effective:
As you see from the table below, despite sacrificing some of her salary, her take-home pay has actually gone up because she is paying less tax.
| Before salary sacrifice | After salary sacrifice | |
|---|---|---|
| Annual gross salary | £30,000 | £28,500 |
| Employee contribution to pension | £1,200 (£1,500 after pension tax relief at 20% on contributions for basic-rate taxpayers) | £0 (because the pension contributions are counted as coming from the employer rather than the employee) |
| Total employer contribution to pension | £900 gross | £2,400 gross |
| Total income tax paid | £3,486 | £3,186 |
| Total national insurance paid | £2,091.60 | £1,911.60 |
| Take-home pay | £23,222.40 | £23,402.40 |
Bonus sacrifice, if your employer offers it as an option, allows you to give up some or all of your bonus and pay it into your pension instead. At the same time you don’t pay tax or national insurance on the part of your bonus that you give up.
If you are in a position to sacrifice your bonus now it can equate to a significant boost for your future self.
For example, if a basic rate taxpayer gives up a one-off £5,000 bonus via bonus sacrifice, rather than have £3,600 now after tax, they could have £13,267 after 20 years (assuming annual 5% investment growth).
Similarly, if a higher rate taxpayer did the same, they would be giving up £2,900 after tax, in order to have the same £13,267 after 20 years (assuming annual 5% investment growth).
The childcare voucher scheme is another long-standing way of taking up salary sacrifice – you use it to pay for care by a registered provider.
Although the scheme closed to new members in October 2018, parents who joined before then can remain in it for as long as they stay with that employer (and for as long as the employer agrees to run it).
Childcare vouchers have now largely been replaced by the government’s tax-free childcare scheme. However, this does not use salary sacrifice and instead gives eligible parents a 25% top-up via an online account.
If, however, you have access to a workplace nursery (either on-site or via a link-up with a local nursery) you may be able to use salary sacrifice to pay for it.
A basic-rate taxpayer with a £1,000 a month nursery bill can save £2,280 a year. Savings increase to £4,170 a year for a taxpayer on the higher income tax rate of 40%.
Your employer might even offer you a company car through salary sacrifice, where the employer leases a car on behalf of the employee.
Here, payments towards your new company car are made from deductions to your pre-tax salary – in other words, you reduce your salary and use that money to pay for it.
However, rules introduced in 2017 have reduced the appeal of salary sacrifice car schemes. This is because you now need to pay income tax either on the value of the car or the amount of salary that you sacrifice.
There is a way to get round this, though. You can get the full benefit of salary sacrifice if you use it to purchase an ultra-low emission vehicle (ULEV), such as an electric car.
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Cycling to work is a great way to get fit, help the environment and save money on commuting. But a decent bike, not to mention all the gear, can be expensive.
This is where the Cycle to Work scheme can help. You choose your bike plus any safety equipment you need, and your employer pays for it.
You then repay this money using salary sacrifice each month, giving you a tax and national insurance saving.
There’s no official limit, although you cannot reduce your pay so much that your earnings fall below the national minimum wage.
So how much salary you can sacrifice depends on what your employer offers.
With additional pension contributions made through salary sacrifice, you’ll be limited by the legal caps on how much people can put into a pension tax-efficiently each year. This is normally how much a person earns up to a maximum of £60,000.
It’s best to speak to a financial adviser to ensure you’re not inadvertently going over the limit and incurring extra tax, before you opt into additional pension contributions.
Salary sacrifice can be a savvy move. But there are pros and cons, depending on your personal situation.
It can even work against you – if you want to apply for a mortgage, for example, your pay will be lower from the salary sacrifice.
You should also check with your employer to find out whether it will have any impact on bonuses, pay increases or other work-related benefits.
For some people, it could help significantly with reducing how much income tax they pay. This is especially important since the government’s freeze on thresholds for income tax and national insurance is set to continue until 2028.
Over time, inflation leads to higher salaries – to see that, you only need to ask your parents how much they earned in their twenties. When the thresholds for income tax aren’t raised to keep pace with rising wages, it means more people end up in higher tax brackets, which is called fiscal drag.
The frozen thresholds for income tax mean this is happening now. The Office for Budget Responsibility (OBR) estimates that 70,000 people will become higher-rate taxpayers in the 2024-25 tax year, as their pay rises above the £50,271 threshold. Earnings above this are taxed at 40%.
The main drawback with salary sacrifice is that it reduces your taxable salary. This can have an impact in a number of areas:
When you submit a mortgage application you need to provide payslips. Lenders offer mortgages based on a multiple of your salary, and they look at all deductions on your payslip. So potentially, salary sacrifice could limit how big a mortgage you can get.
If you get a life insurance policy through salary sacrifice, it could mean the insurer is looking at you as someone who earns less. Because life insurance payouts are based on a multiple of your salary, this could affect the payout for you or your loved ones if you become too ill to work, or if you die.
You should check with your employer if the life cover is based on your whole pay or your pay after the salary sacrifice.
Sometimes people opt in to extras they don’t actually need through salary sacrifice. It can be easy to forget you’re paying for it because the money is taken before your salary arrives, and a lot of people don’t look at their pay slip.
With salary sacrifice your employer has an agreement with specific providers, like the local gym or an insurance company. Some of these things you can get cheaper elsewhere, for example within packaged current accounts, which is where high street banks such as Nationwide and Halifax offer customers free worldwide travel insurance with some of their accounts.
It’s worth checking whether the provider you’ll be going with through your work’s salary sacrifice scheme is actually the best one for you.
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Times Money Mentor shows you how in September with its free four-week newsletter course. Sign up now for a richer retirement. When you subscribe, you will also receive our weekly newsletter.
By entering your details, you agree these will be used according to our privacy policy. You can unsubscribe, although if you do you will stop receiving both newsletters.
Look out for the first email on 3 September. You'll also receive our regular weekly round-up of money matters.
Times Money Mentor shows you how in September with its free four-week newsletter course. Sign up now for a richer retirement. When you subscribe, you will also receive our weekly newsletter.
By entering your details, you agree these will be used according to our privacy policy. You can unsubscribe, although if you do you will stop receiving both newsletters.
Look out for the first email on 3 September. You'll also receive our regular weekly round-up of money matters.
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