Pensions salary sacrifice: what employers need to know

Pensions salary sacrifice is offered by 61% of employers, according to Employee Benefits’ Benefits research 2014, published in May, but what is it? Here are some of the most common questions employees ask about the benefit. 

If you read nothing else, read this…

  • Pensions salary sacrifice involves employees sacrificing a proportion of their salary to contribute into their pension scheme.
  • Salary sacrifice can reduce income tax and national insurance contributions for both employers and employees.
  • The term ’salary sacrifice’ is increasingly being replaced with ’salary exchange’. 
More than a million older workers in employment

What is pensions salary sacrifice?

Pensions salary sacrifice involves employees sacrificing a portion of their salary to contribute into their pension scheme.

Instead of a pension scheme member agreeing to pay, say, £50 of their salary direct to their pension scheme provider, they agree with their employer that their pay is contractually reduced by £50 per month, and that the employer makes this contribution to the pension scheme in addition to any contribution that the employee makes.

Salary sacrifice arrangements enable employees and employers to make tax and national insurance (NI) savings because the member’s pension contribution is taken out of gross pay. 

According to The Benefits Research 2014, 61% of employers provide salary sacrifice pension schemes and 34% offer these via a flexible benefits plan.

How does it work?

If an employee earns £30,000 per year and sacrifices £1,000 per month, their salary will be £29,000, which is the amount that is then subject to tax and national insurance (NI). 

Without salary sacrifice, a member contribution of £100 would be subject to 13.8% employer NI.

Dale Critchley, pensions technical manager at Friends Life, says that pensions salary sacrifice simply makes pension contributions more affordable for both staff and employers. 

“Employers save 13.8% through salary sacrifice compared to regular pensions contributions; it’s cheaper for everyone,” he says.

John Chilman, group pensions and rewards director at FirstGroup , adds: “Pensions salary sacrifice is a way for members to pay for their pension in a more NI-efficient way”.

Employee contracts need to be changed to illustrate any change of salary, but employers need to adhere to minimum wage laws.  

Critchley says: “Contract changes need to be applied prior to implementation date; about six months is sufficient time.

“[Employers need to] engage with payroll to find out who salary sacrifice is appropriate for and who it isn’t. For example, those on or near to the national minimum wage, or part-time workers, could lose out on statutory maternity pay.”

He says that it is crucial that employers make the necessary changes in contract of employment, which is legally enforceable. “And make sure that the changes can be upheld,” he adds.  

What could go wrong?

The tangible result of sacrificing part of a salary is that it will decrease, which could result in an employer breaching the minimum wage laws.

Employers must also consider that staff may be involved in multiple salary sacrifice arrangements , which could also result in the same outcome. 

Salary sacrifice also involves vast amounts of administration and HR work, which employers may not have the capacity to manage. 

A common mistake that many employers make when implementing salary sacrifice is failing to thoroughly review their HR processes and as well as, in some cases, failing to provide a lack of effective communication and exchange of information with staff.

What can employers do with their NI savings?

Employers may reinvest all, or part of, their NI savings into their employees’ pension funds, but this is not always the case.

By sharing their savings, employers can make their pensions scheme more attractive to staff, but employers and employees must communicate that they do this to reap the benefits. 

Paul Nanon, partner at Aon Employee Benefits, says that the majority of employers do not share their NI saving.

“Employers that do share their NI saving typically have a highly paid workforce who would only benefit from a 2% marginal NI-rate saving, so sharing the employer NI saving encourages participation.”

What are DC pensions?

Defined contribution (DC) pensions build up a pension fund using employee and employer contributions (if applicable) plus investment returns and tax relief.

Pension pots can be invested in stocks, shares or other investments, and under new government proposals, from April 2015, scheme members will have greater flexibility about how they access and use their pension from age 55.

Employees could invert their pot in to an annuity, take up to 25% tax-free, or withdraw the cash in stages or as one lump sum.

What is salary exchange?

The term ‘salary exchange’ is being used more commonly than salary sacrifice due to the negative connotations surrounding ‘sacrifice.’

First Group’s Chilman says: “It’s less emotive. The term sacrifice sounds like [employees] are giving something up, while exchange is a more accurate reflection of what is happening; members are exchanging salary for a bigger company contribution into their pension plan.”

Employers tend to want their workforce to understand that their wages are not being taken away, but used for saving. Salary exchange can also provide workers with the opportunity to increase their pension pot without affecting net income. 

What issues can auto-enrolment create?

Almost half (48%) of UK employees have not been sufficiently informed about auto-enrolment by their employers, according to research from Office Angels, carried out between November and December 2013, and published in February 2014.

Moreover, The Pensions Regulator’s (TPR) annual commentary and analysis report, released this September, found that 785 potential non-compliance cases were referred for investigation, and 23 auto-enrolment compliance notices were issued.

The main challenges with auto-enrolment include the extra administration involved, such as keeping record of staff that opt out of a scheme as well as staff communication.

TPR recommends that articles, texts or emails and posters are some of the most effective ways to communicate auto-enrolment to staff.

After their auto-enrolment staging date, employers are required to monitor staff who will become eligible for auto-enrolment each month, or those with pay rises bringing them above the qualifying earnings threshold.

Chilman says: “As the act of auto-enrolment must be completely passive. The member may not realise what is happening, particularly when they see the gross pay go down. They may not understand the concept of the reference pay, which means their pensionable pay and reference pay for other benefits, does not decrease as a result of this.”

Angela Smith, managing director at Office Angels, adds: “A shift is needed in attitudes towards pensions in the UK. HR professionals need to take the necessary steps to prepare, otherwise they risk damage to their employer brand, a drop in overall engagement levels and a breakdown of the relationships they’ve built with their employees.”

Where can employers source more information?

HM Revenue and Customs’ (HMRC) website provides salary sacrifice guidance:

HMRC’s clearance team can vet salary sacrifice arrangements, based on the evidence provided to show the contract of employment has been changed and the salary given up, to ensure everything is in order. Contact: [email protected]

Case study: FirstGroup

First Group


Boosting pay through salary sacrifice

FirstGroup, which has more than 120,000 employees worldwide, has offered a pensions salary sacrifice arrangement since making changes to its employee benefits in 2005-2006. 

John Chilman, group reward and pensions director, says: “Initially, we called this ‘pay boost’ because existing members going into the scheme boosted their take-home pay, because they paid less national insurance. However, we changed the name to ‘salary adjustment’ in the UK, because the ‘pay boost’ term was not appropriate for colleagues who were saving into pension for the first time.”

FirstGroup reinvests some of the NI savings made as additional benefits to staff in the scheme.

When deciding which members of staff are most suitable for the scheme, FirstGroup auto-enrolled those under the age of 22 on a contractual basis, as well as those below the qualifying earnings threshold.

It has also had to consider its approach to temporary workers. Chilman says: “We’re looking at the approach we take to casual staff, as auto-enrolling them can cause frustration when they come back to work for us for a short period, and find that a pension deduction has been made.”

When implementing pensions salary sacrifice, to both its defined benefit (DB) pension scheme for existing members and a new trust-based defined contribution (DC) scheme for new members, First also had to decide whether to allow employees to opt in or opt out was a key consideration.

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Chilman explains: “If you make it passive you will get a much higher take-up. Once we found this out we used the opt-out approach, and most individuals don’t.”


  • 81% of employers offer staff a pension .(Employee Benefits’  Benefits Research, May 2014)
  • 75% of employers offer matching pension contributions, a number that has doubled in the last decade. (FTSE 350 DC Pensions survey, April2014)
  • This year, 87% of employers that offer benefits via salary sacrifice enable staff to make contributions in this way, either through a voluntary or flexible benefits scheme . (Employee Benefits’  Benefits Research,  May 2014)