Nov 26, 2025 5 min read Economy

Salary sacrifice explained: how it works and what's changing

Salary sacrifice arrangements have become a popular way for employees to boost their pension savings whilst reducing their tax bills. However, the UK Budget 2025, announced on 26 November 2025, introduced significant changes that will affect how these schemes work from 2029 onwards.

If you use salary sacrifice for your pension contributions, or if you're considering it, here's what you need to know about how the system works today and what's set to change.

What is salary sacrifice?

Salary sacrifice, also known as salary exchange, is an arrangement where an employee agrees to give up part of their gross salary in exchange for a non-cash benefit. Whilst this can apply to various benefits such as childcare vouchers or cycle-to-work schemes, pension contributions through salary sacrifice have grown substantially, with costs forecast to increase from £2.8 billion in 2016-17 to £8 billion by 2030-31 without the reforms announced in this Budget.

The arrangement is particularly attractive for pensions because both the employee and employer can save on National Insurance contributions (NICs). The employee's salary is reduced before tax and NICs are calculated, and the employer pays the agreed amount directly into the employee's pension pot.

How salary sacrifice works currently

Under current rules, there's no limit on the amount you can contribute to your pension through salary sacrifice before it becomes subject to National Insurance. This makes it one of the most tax-efficient ways to save for retirement.

Here's a simplified example of how it works:

Without salary sacrifice:

Gross salary: £40,000
Employee NICs (8%): £3,200
Income tax (20%): £5,486
Employer pension contribution (3%): £1,200
Take-home pay: £31,314

With £3,000 salary sacrifice:

Reduced gross salary: £37,000
Employee NICs (8%): £2,960
Income tax (20%): £4,886
Employer pension contribution (£1,200 + £3,000 salary sacrifice + employer NI saving): £4,608
Take-home pay: £29,154

In this example, the employee's take-home pay is £2,160 lower, but their pension receives £3,408 more. The employee saves £240 in NICs and £600 in income tax, whilst the employer saves approximately £408 in NICs, which is often added to the pension contribution.

Who uses salary sacrifice?

Research earlier this year suggested that about 48% of all UK private sector companies offer salary sacrifice pension contribution systems, rising to about 67% at larger firms and up to 85% for the biggest employers Portfolio Adviser. Around a third of private sector employees make use of salary sacrifice arrangements, whilst almost 10% of public sector workers do so.

The arrangements are particularly valuable for employees who want to save more than the auto-enrolment minimum contributions. Under auto-enrolment, the minimum total contribution is 8% of qualifying earnings, with at least 3% from the employer.

What's changing from April 2029

The Budget 2025 introduces a £2,000 cap on salary sacrifice into pension schemes, with contributions above that threshold taxed in the same way as other employee pension contributions from April 2029.

This means:

Salary-sacrificed pension contributions up to £2,000 per year will continue to receive full National Insurance relief
Any contributions above £2,000 will be subject to employee NICs at 8% for earnings below £50,270, and 2% for earnings above that threshold
Employer NICs will also apply to the amount above £2,000
Income tax relief on pension contributions will remain unchanged

The cap applies to the combined total of employee and employer salary sacrifice contributions, not separate limits for each.

Who will be affected?

The government states the cap shields 74% of basic rate taxpayers using salary sacrifice, meaning roughly a quarter of current users will see changes to their arrangements.

Those most likely to be affected include:

Higher earners who make substantial pension contributions through salary sacrifice
Employees whose employers contribute generously above the auto-enrolment minimum using salary sacrifice
Anyone currently sacrificing more than £2,000 of their salary into their pension

Under the current minimum auto-enrolment contribution rates, someone earning less than £40,000 per year who only makes the minimum contributions will not be affected by these changes.

Why is the government making this change?

The government's stated rationale centres on fairness and cost control. The costs of relief through salary sacrifice relate disproportionately to pension contributions from those on higher incomes, with the greatest benefits going to higher earners whilst minimum wage employees are excluded from salary sacrifice arrangements.

The measure is expected to raise £4.7 billion in 2029-30, helping to fund other Budget priorities including the removal of the two-child limit on Universal Credit benefits.

Practical implications

If you currently use salary sacrifice for pension contributions above £2,000, you have until April 2029 to consider your options. Between now and then, you can:

Continue as normal: You'll benefit from full National Insurance relief until the changes take effect. This gives you roughly three and a half years to maximise the tax advantages of salary sacrifice.

Review your pension contributions: Work with your employer to understand how the changes will affect your take-home pay and pension savings. You may wish to adjust your contribution levels.

Consider other pension contribution methods: After April 2029, contributing above £2,000 via salary sacrifice will be less tax-efficient than it is now, though you'll still receive income tax relief through the pension system. You might want to explore relief at source or net pay arrangements for contributions above the threshold.

Check your overall pension allowance: Remember that the annual allowance for pension contributions (currently £60,000 for most people) remains unchanged. The salary sacrifice cap is separate from this.

What stays the same

It's important to note what isn't changing:

Income tax relief on pension contributions remains at your marginal rate (20%, 40%, or 45%)
The annual allowance for pension contributions is unchanged
Auto-enrolment and tax relief worth over £70 billion per year continues
Salary sacrifice arrangements for benefits other than pensions (such as electric vehicles or cycle-to-work schemes) are not affected by these changes
Contributions up to £2,000 via salary sacrifice will continue to receive full National Insurance relief

Looking ahead

The three-and-a-half-year lead time before implementation gives employees and employers time to adapt their pension strategies. However, industry commentators have expressed concern about the potential impact on retirement savings, particularly for those who currently make substantial pension contributions.

Some employers may need to restructure their pension schemes or consider alternative ways to support employee retirement savings. The Office for Budget Responsibility has acknowledged that some employers may look to adjust employment contracts in response, though it expects this to be limited in practice.

There are also question marks if the measure will go-ahead as announced, but time will tell if the government will stick to it.

For now, salary sacrifice remains a valuable tool for pension saving. If you use it, or are considering it, speak to your employer about how these changes might affect you, and consider taking advantage of the current system whilst it remains unchanged.