How does salary sacrifice work for pensions?

Full answer

Salary sacrifice (also called salary exchange) is an arrangement where you agree to reduce your gross salary by an amount, and your employer pays an equivalent sum directly into your pension. Because the contribution never reaches your payslip as salary, neither you nor your employer pays tax or NI on it. **Effective tax saving at basic rate (2026/27):** - Income tax: 20% - Employee NI: 8% - **Total employee saving: ~28%** on every £1 sacrificed - Employer NI saved: 15% — many employers pass this on to the employee as an extra pension contribution **At higher rate:** - Income tax: 40% - Employee NI: 2% (above Upper Earnings Limit) - **Total employee saving: ~42%** on each £1 above £50,270 **How it appears on your payslip:** Your gross salary is shown as reduced (e.g. from £40,000 to £36,000 after £4,000 sacrifice). Your employer then makes the full £4,000 pension contribution. Your P60 and income figure for mortgage applications will reflect the lower £36,000. **Important limits and caveats:** - Your post-sacrifice salary cannot fall below the **National Living Wage** (£12.71/hour for 21+ in 2026/27). - Salary sacrifice reduces your **pensionable pay** for some defined benefit schemes — check with your scheme. - It can reduce **Statutory Maternity Pay (SMP)** and **mortgage affordability assessments** as lenders use actual salary. - **State Pension** is unaffected — NI credits are based on the notional pre-sacrifice salary under current rules. **Pension Annual Allowance:** Total contributions (employee + employer + salary sacrifice) must not exceed £60,000 per year (or 100% of earnings). Use carry-forward for larger contributions.

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