Ruth Jackson-Kirby
You can use salary sacrifice as a way of boosting your pension contributions at no additional cost to yourself. But it can have a knock-on effect on other work benefits and your state pension.
Find out about salary sacrifice and pensions and what you need to consider before you agree to it.
How does salary sacrifice work?
Salary sacrifice schemes give you, as an employee, the opportunity to swap part of your salary for a benefit such as childcare vouchers, a company car, or increased pension contributions.
Employers like salary sacrifice because it reduces how much National Insurance they have to pay on your behalf as your earnings are lower.
The benefit for you is that it could help you avoid becoming a higher-rate taxpayer. And although your take home pay will be reduced, the savings you make could outweigh the loss.
What is salary sacrifice for a pension?
Salary sacrifice for pensions means you take a salary cut and your employer pays an amount equal to your salary reduction into your pension. The money you are saving on National Insurance contributions and income tax means you can afford to pay more into your pension. Plus, some employers will pay the savings they make on National Insurance into your pension.
This all means you can make the same level of pension contribution at a lower cost to yourself. For example, let’s say you earn £25,000 a year (£20,000 after tax) and you pay 5% of that into your pension and your employer contributes 3%. You are paying £1,000 a year into your pension, and tax relief and employer contributions take it up to £2,000.
If you agree to reduce your annual salary by £1,000, your annual salary after tax will fall to £19,200 so you will get £800 less a year in your pocket. You carry on making your 5% pension contribution, but this falls from £1,250 (including tax relief) to £1,200. Your employer still makes a 3% contribution plus the £1,000 salary sacrifice.
After salary sacrifice you would be paying £2,920 a year into your pension – an extra £920 – but only losing £800 of take-home pay.
Pros and cons of salary sacrifice for pensions
Pros
- It is a cheap way to boost your pension contributions.
- It can help you avoid moving up an income tax band.
- It can be a more tax-efficient way to make pension contributions if you are a higher- or additional-rate taxpayer as you won’t have to claim tax relief from HMRC.
Cons
- Reducing your salary may affect other benefits, such as sick pay, paid leave or maternity pay.
- Your smaller salary could cause you problems if you want to move to a new house or remortgage. Mortgage lenders usually lend you a multiple of your salary.
- Salary sacrifice might boost your private pension, but if you’re a low earner it could put a dent in your state pension.
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Will salary sacrifice affect my state pension?
By reducing your salary, you will pay less tax. Sounds great – but remember that it means you will also pay less National Insurance, which is used to calculate how much state pension you eventually receive.
You need 35 years of National Insurance contributions to qualify for the full state pension. Salary sacrifice will affect this only if your taxable income drops below the lower earnings limit, which is £123 a week or £533 a month for the 2024/25 tax year. If that happened, you would stop making NICs, which could impact your state pension.
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