Salary sacrifice schemes offer a clever way for both employers and employees to maximise their financial positions through tax efficiency. These arrangements involve employees agreeing to receive a lower cash salary in exchange for non-cash benefits of equivalent value. This guide breaks down everything HR teams need to know about implementing and managing salary sacrifice schemes, from the basic mechanics to the potential benefits and drawbacks for all parties involved.
What is salary sacrifice?
This concept (sometimes called salary exchange) represents a contractual arrangement between an organisation and its staff. Under such a scheme, a person agrees to reduce their gross pay in return for receiving a non-cash return. This modifies the contract of employment, with the person effectively “sacrificing” part of their pre-tax earnings in exchange for something else of value.
Common examples include pension payments, childcare vouchers, cycle-to-work schemes, and electric company cars. The key advantage lies in the tax treatment: since the return is taken from the gross figure before tax calculations occur, both parties often pay less income tax and national insurance.
HMRC recognises and regulates these arrangements, setting specific rules about implementation and implications. While these schemes offer advantages for many workers, they are not suitable for everyone, particularly those earning close to the national minimum wage, as reducing gross salary could push earnings below legally required levels.
Further Reading: The Leading Corporate Spending Trends in 2026
How does salary sacrifice work?
These arrangements operate through a straightforward but formal process. First, both parties must agree to amend the contract, reducing the person’s earnings in exchange for something of similar value. This change must be properly documented and established.
When implemented, the gross pay – the amount before deductions – is reduced. This lower figure then becomes the basis for calculating income tax and national insurance, often resulting in lower deductions overall. The organisation then provides the agreed non-cash return, which may receive favourable treatment depending on its nature.
For example, if someone earning £30,000 annually agrees to exchange £2,000 for increased pension payments, their taxable income becomes £28,000. Both parties save on national insurance on the exchanged amount, while the person also pays less income tax. The organisation then puts the full £2,000 into the pension pot.
Importantly, these arrangements must genuinely modify the employee’s contract and cannot be set up merely as a tax or national insurance avoidance scheme. The arrangement should represent a true exchange, where the person receives something of comparable value to the earnings given up.
What types of non-cash benefits are available?
These schemes can provide various non-cash returns, each with distinct advantages. Understanding the options helps organisations create packages that appeal to their workforce and maximise efficiency.
The most common non-cash returns provided through these arrangements include:
- Pension payments. Additional payments to workplace pension schemes represent one of the most efficient options available.
- Childcare vouchers. While closed to new entrants since 2018, existing schemes allow workers to receive vouchers, reducing childcare costs.
- Cycle-to-work schemes. These allow access to bicycles and related safety equipment, promoting healthier commuting while spreading costs.
- Ultra-low emission vehicles. Electric and hybrid vehicles available through these schemes offer significant advantages following recent government incentives.
Less common but still available options include:
- Mobile phones and technology packages
- Additional holiday purchase schemes
- Gym memberships
- Private medical insurance
- Professional subscriptions and training courses
Each carries different implications, with some offering complete exemption from taxation and others providing partial relief. Monthly payments remain consistent throughout the arrangement, creating predictable financial commitments for both parties.
When selecting options to offer, HR teams should consider the demographic composition of their workforce and the specific needs of different groups. A thoughtfully constructed package increases satisfaction while delivering cost savings across the organisation.
How do salary sacrifice schemes work?
Setting up and running such a scheme requires careful planning and administration. The process usually follows these steps:
- First, the organisation must design the scheme, selecting which non-cash returns to offer and establishing rules regarding eligibility and levels. Clear policies help prevent misunderstandings and compliance issues later.
- Next, organisations must communicate the scheme to staff, explaining how these arrangements operate and the potential advantages and disadvantages. This communication should highlight both the savings and possible impacts on earnings-related provisions.
- Those wishing to participate must formally agree to the contractual change, usually through an online form or a signed salary sacrifice agreement. This agreement modifies their existing contract, establishing the reduced cash earnings and the non-cash return they will receive instead.
- Once implemented, the payroll system needs adjustment to reflect the lower gross salary. Monthly payslips will show the reduced figure, with accompanying notes often explaining the arrangement. The organisation must maintain accurate records of all agreements for reporting purposes.
For pensions specifically, the process works by reducing the person’s gross salary by the agreed amount, with the organisation then making the full pension payment directly. This differs from normal pension payments, where the individual contributes from their post-tax earnings.
These arrangements tend to run for at least 12 months, though changes may be permitted in cases of major life events such as marriage, divorce, birth of a child, or significant changes in financial circumstances. HMRC permits such flexibility when genuine lifestyle changes occur.
Further Reading: Expense Card for Contract Employees Explained: A Comprehensive Guide
What is the effect of salary sacrifice on tax and National Insurance contributions?
Salary sacrifice arrangements create meaningful implications for both organisations and their staff. For individuals, the immediate impact appears in reduced income tax liability. Since the exchange lowers taxable income, people pay less employment income tax overall. The exact savings depend on their tax band – basic, higher, or additional rate. Higher-rate taxpayers often see significant income tax advantages from these arrangements.
National Insurance also decreases for individuals. With a lower gross figure, people pay lower NI each month. For the 2025/26 tax year, most employees pay 8% on earnings between £12,570 and £50,270, and 2% on earnings above this threshold, making the potential savings substantial.
Organisations also pay lower national insurance. The NI rate (15% for the 2025/26 tax year) applies to a reduced gross figure, generating meaningful savings, particularly in larger workplaces with many participating staff.
However, these advantages come with important considerations regarding statutory payments. Work-related statutory payments like sick pay, maternity pay, and redundancy pay rely on average weekly earnings calculations. Lower recorded earnings through these arrangements might reduce these provisions, though recent legislation mitigates some of these effects.
Pros of salary sacrifice for employers and employees
The arrangements offer substantial advantages for both parties in the employment relationship, explaining their growing popularity across UK businesses.
For staff, the advantages include:
- Tax efficiency. People pay less income tax because their taxable income decreases.
- Lower national insurance. With reduced gross pay, NI payments decrease accordingly.
- Increased pension savings. In pension-based schemes, more money goes directly into retirement funds without deductions.
- Access to valuable returns. People receive things like electric vehicles or technology packages at lower effective costs.
- Simplified process. For pensions, these arrangements streamline the payment procedure.
Organisations gain several advantages as well:
- Reduced national insurance. Lower payments mean reduced NI liability, creating significant savings.
- Enhanced packages. Offering attractive options helps with recruitment and retention.
- Increased satisfaction. When properly communicated, these schemes demonstrate investment in staff wellbeing.
- Administrative simplification. For pension contributions, the approach can simplify processing.
- Compatibility with flexible platforms. These schemes integrate well with broader systems.
The financial advantages often create win-win scenarios. For example, organisations might share their national insurance savings with staff by adding those amounts to pension payments, further enhancing the return. This approach turns the organisation’s savings into additional value for workers.
The positive impact on recruitment and retention shouldn’t be underestimated. At a time when attracting talent presents challenges, a well-structured programme differentiates organisations and signals commitment to staff’s financial wellbeing.
Cons of salary sacrifice for employers and employees
Despite the advantages, the salary sacrifice schemes present several potential drawbacks that require careful consideration before implementation.
For staff, these disadvantages include:
- Reduced earnings-related provisions. Lower recorded pay may reduce statutory payments like maternity pay, sick pay, and redundancy payments.
- Mortgage application issues. Some lenders base borrowing calculations on basic pay rather than total package, potentially reducing borrowing capacity.
- Impact on means-tested provisions. Lower recorded income might affect eligibility for things like tax credits or Universal Credit.
- Minimum wage considerations. People cannot exchange pay that would reduce their earnings below minimum wage levels.
- Lock-in periods. Most arrangements commit participants for at least 12 months, reducing financial flexibility.
Organisations also face potential challenges:
- Administrative complexity. Setting up and maintaining these schemes requires careful record-keeping and regular reviews.
- Communication requirements. Explaining the advantages and drawbacks clearly demands significant communication effort.
- Legal compliance obligations. Schemes must satisfy HMRC requirements and employment law considerations.
- Regular review necessity. Rules change frequently, requiring ongoing compliance monitoring.
- Staff confusion risk. Complex arrangements may confuse people, potentially reducing participation or creating dissatisfaction.
The impact on provisions that calculate from average weekly earnings presents a particular concern. Though legislation protects some statutory payment calculations, reduced gross pay could still affect certain state provisions and employees’ entitlements.
The minimum wage limitation creates implementation challenges for lower-paid workers. Organisations cannot offer arrangements that would take pay below legal minimum levels, potentially excluding some workers from the scheme advantages. Finally, proper scheme management requires ongoing attention, especially with changing regulations and circumstances.
What are the tax savings for employees?
The savings from these arrangements represent a primary attraction for many staff. These financial advantages stem primarily from reduced income tax and national insurance liabilities.
When someone exchanges part of their pay, they reduce their taxable income. For basic rate taxpayers (20% tax rate), every £100 exchanged saves £20 in income tax. Higher rate taxpayers (40%) save £40 per £100, while additional rate taxpayers (45%) save £45 per £100.
National Insurance also decreases significantly.For the 2025/26 tax year, people usually pay 8% NI on earnings between £12,570 and £50,270. For earnings within this band, every £100 exchanged saves £8 in National Insurance. For earnings above £50,270, the savings equal 2% of the exchanged amount.
Example:
A person earning £40,000 annually agrees to exchange £5,000 for pension payments. Their savings include:
- Income tax saving: £5,000 × 20% = £1,000
- National insurance saving: £5,000 × 8% = £400
- Total annual saving: £1,400
Additionally, the full £5,000 goes into their pension contributions rather than the smaller amount that would remain after normal taxation. This creates significant long-term advantages for retirement planning.
For options like electric vehicles, childcare vouchers, or cycle-to-work schemes, the treatment varies. Most receive favourable treatment, but the exact savings depend on the specific return and the person’s position.
Working tax credit and other tax credits calculations rely on taxable income figures. Since the arrangements reduce this figure, some people may qualify for these provisions or receive increased payments, though this depends on individual circumstances and should be carefully evaluated.
Further Reading: What Your Employees’ Expense Habits Say About Your Company Culture
Examples of salary sacrifice pension
Pension-based salary sacrifice arrangements represent the most common and financially advantageous form of these schemes. The examples illustrate how they work in practice.
Example 1: Basic Rate Taxpayer
Mary earns £35,000 annually and currently contributes 5% (£1,750) to her workplace pension contributions scheme from her post-tax salary. Her employer matches this with 5%.
Under a salary sacrifice arrangement, Mary agrees to reduce her salary by £1,750, with her employer making an equivalent additional pension contribution instead. This creates:
- Income tax saving: £1,750 × 20% = £350
- National insurance saving: £1,750 × 8% = £140
- Total annual saving: £490
Mary’s employer also saves £262.50 in employer’s national insurance (£1,750 × 15%). Some generous employers add this saving to the pension contribution, further boosting Mary’s retirement fund.
Example 2: Higher Rate Taxpayer
James earns £60,000 and contributes 8% (£4,800) to his pension. Through employee’s salary sacrifice, his tax savings amount to:
- Income tax saving: £4,800 × 40% = £1,920
- National insurance saving: £4,800 × 2% = £96
- Total annual saving: £2,016
Over time, these tax advantages compound significantly. For James, the annual £2,016 saving over a 25-year period creates substantial additional wealth, even before considering potential employer NI contributions.
Example 3: Minimum Contribution
Emma earns £25,000 annually. Under auto-enrolment rules, she must contribute at least 5% (£1,250) to her pension, with her employer contributing 3% (£750).
Through salary sacrifice, Emma exchanges £1,250 of salary for an equivalent employer pension contribution. Her savings include:
- Income tax saving: £1,250 × 20% = £250
- National insurance saving: £1,250 × 8% = £100
- Total annual saving: £350
Emma’s employer also saves £187.50 in employer’s national insurance (£1,250 × 15%). In some cases, employers may choose to add this saving to the pension, further increasing the total contribution.
These examples demonstrate why pension salary sacrifice arrangements have become so popular. The immediate tax savings combined with long-term pension pot growth create compelling financial advantages for employees across income brackets.
Explore Wallester’s payroll program for employees
Wallester’s Payroll Programme simplifies employee payment processes while also supporting salary sacrifice arrangements. This system helps businesses manage payroll more efficiently by issuing both virtual and physical Visa cards for salary disbursement. Employees can access their pay instantly, whether on payday or for specific benefit-related payments.
Key features of the Wallester Payroll Program:
- Flexible payment options. Issue both virtual and physical cards to employees, allowing easy access to wages and salary sacrifice benefits.
- Batch payment capability. Handle up to 1,500 transactions at once, making the system suitable for large teams.
- Integration with payroll systems. The platform connects seamlessly with existing accounting and payroll software via REST API, automating data entry and reducing errors.
- Real-time access. Employees can view their salary details and manage their funds through the Wallester mobile app, compatible with Apple Pay and Google Pay.
- Cost efficiency. The platform helps reduce administrative workload, saving time and resources for payroll management.
- Enhanced compliance. Automated updates keep the system aligned with changing regulations, reducing the risk of non-compliance.
Wallester’s solution is very useful for managing salary sacrifice schemes as it tracks salary adjustments, tax savings, and employer contributions in real time. This approach makes it easier to maintain accurate records and produce necessary documentation.
