Salary sacrifice is a formal agreement where an employee gives up part of their gross salary in return for a non cash benefit, such as a pension contribution. Because the sacrificed pay never counts as salary, it can cut Income Tax and National Insurance for the employee and employer National Insurance for the employer. Since April 2017 most benefits lost that advantage, but pensions, pensions advice, childcare, Cycle to Work and ultra low emission cars stay protected. Pension sacrifice remains the most powerful option.

Salary sacrifice sounds technical, but the idea is simple. You agree to take a lower cash wage, and your employer puts the difference towards a benefit you want. The money is redirected before it is taxed, so you and your employer both pay less to HMRC on that slice of pay. For company directors and owner managers, a well set up scheme can be one of the most efficient ways to fund a pension. This guide explains how it works, what the tax rules now allow, and where the genuine savings still sit.

How does salary sacrifice actually work?

Salary sacrifice is a contractual change to your terms of employment. You and your employer agree in writing to reduce your gross salary by a set amount, and in exchange the employer provides an agreed benefit of equivalent value. The most common example is a pension. If you sacrifice £5,000 of salary into your workplace pension, that £5,000 is no longer treated as earnings, so no Income Tax and no employee National Insurance is due on it. Your employer also saves the employer National Insurance it would have paid on that £5,000.

Because the arrangement changes your actual pay, it has to be set up properly. HMRC expects a genuine variation to the employment contract, agreed before the sacrifice begins rather than backdated. You cannot simply relabel existing pay after it has been earned.

What tax and National Insurance does it save?

The savings come from three separate charges that the sacrificed pay avoids. The employee escapes Income Tax at their marginal rate and employee National Insurance on the sacrificed amount. The employer escapes employer National Insurance on the same figure. Many employers pass some or all of their own saving back into the benefit, so the full value working for you can be larger than the salary you gave up.

There is a second benefit for higher earners. Because sacrifice reduces your gross salary, it also reduces your adjusted net income. That can help anyone caught by the £100,000 threshold where the personal allowance is withdrawn. You can read more about that trap in our guide to personal allowance tapering.

What changed under the Optional Remuneration rules?

From 6 April 2017 HMRC introduced the Optional Remuneration Arrangements rules, usually shortened to OpRA. Before then, many benefits provided through sacrifice were taxed only on their reported value, which was often low or nil. Under OpRA, most benefits are now taxed on the higher of the cash you gave up or the normal taxable value of the benefit. In practice that removes the tax advantage for the majority of perks, because you are taxed as if you had simply kept the salary.

A protected list of benefits was carved out and keeps the full advantage. These are:

  • Employer contributions into a registered pension scheme
  • Employer provided pensions advice
  • Childcare vouchers and workplace nurseries, though voucher schemes closed to new joiners in October 2018
  • Cycle to Work equipment
  • Cars with CO2 emissions of 75g/km or less, taxed under the normal benefit in kind rules

For anything outside this list, such as a standard company car with higher emissions, sacrifice no longer produces the saving it once did. Those benefits are still reported through the usual channels, and you can see how that reporting works in our note on benefits in kind and the P11D. If a company car is on your mind, our guide to company car tax sets out how the charge is calculated.

Why are pensions the strongest use?

Pension sacrifice sits at the top of the protected list and delivers the cleanest result. You avoid Income Tax and National Insurance on the way in, your employer avoids its National Insurance, and the whole amount goes into your pension to grow. For a director deciding how to extract profit, this often beats taking the same money as salary and paying it in afterwards. It also works alongside dividend planning, which we cover in our comparison of salary versus dividends. For the wider rules on relief, see pension contributions and tax relief for business owners.

Has the pension National Insurance saving been cut?

This is the question worrying many owners, so it is worth stating the confirmed position clearly. At the Autumn Budget 2025 the government announced that the employer and employee National Insurance saving on pension salary sacrifice will be capped at £2,000 of sacrificed contributions per tax year. Contributions above that figure will attract National Insurance.

Crucially, that change does not take effect until 6 April 2029. For the 2025/26 and 2026/27 tax years the National Insurance saving on pension sacrifice remains uncapped and fully available. Nothing has changed yet. Income Tax relief on pension contributions is not affected by the announcement at all, so pensions stay a strong planning tool both now and after 2029.

What are the traps to watch?

The main rule is that salary sacrifice must not reduce your cash earnings below the National Minimum Wage. If a sacrifice would push pay under that floor, it cannot go ahead on that portion. Lower earnings can also affect anything linked to salary, such as statutory maternity pay, mortgage borrowing and some state benefits, so the arrangement needs thought rather than a rush.

For a wider look at how these pieces fit together across a business, our accountancy and tax guide pulls the related topics into one place.

A quick word on peace of mind

Salary sacrifice is legitimate and widely used, but HMRC does look closely at how schemes are documented, so getting the paperwork right matters. Solar Protect tax investigation insurance covers up to £100,000 of your accountant’s fees with no excess, so if HMRC opens an enquiry into your arrangements, the cost of a proper defence is taken care of. Get a quote.

Reviewed by Matthew Bartlett, Director, Solar Protect. This guide is general information, not personalised tax or financial advice. Figures are correct for the 2025/26 and 2026/27 UK tax years at the time of writing.