With tax changes on the horizon, understanding how salary sacrifice schemes work is now essential for both employers and employees.
Salary sacrifice schemes are voluntary workplace agreements that reduce an employee’s entitlement to an agreed level of cash pay. In return, the employer is then able to pass back a non-cash benefit to employees to enrich their working experience.
Forthcoming tax reforms, including a salary sacrifice cap from April 2029, may affect how workplace benefits and pension contributions are structured. Understanding how they work, as well as how they might affect employee pension savings, has never been more important.
How does salary sacrifice work?
Salary sacrifice, also sometimes known as a salary exchange, is the voluntary surrender of part of an employee’s gross salary in favour of a benefit. Salary sacrifice agreements must be clearly laid out in an employee’s contract.
Voluntary agreement
The first step of a salary sacrifice scheme will be a discussion about what the exact reduction will be. Pension contributions are the most common types of sacrifices offered, and the employer needs to ensure they are working with the right pension partner to ensure this is adequately accommodated. In addition to the exact purpose, the full deduction needs to be agreed upon between the employer and employee.
Salary reduction
The employees pay will then be reduced by the agreed amount. This often results in the employee owing less income tax than they would on the higher amount. Sacrificed salary is not subject to employer or employee national insurance, so employers and employees alike will usually benefit from a saving.
For example, if an employee earns an annual salary of £51,000 and agrees to sacrifice £5,000 into a pension, their contractual salary would reduce to £46,000. However, from April 2029, National Insurance savings generated through salary sacrifice will be capped by the £2,000 salary sacrifice cap. This means that while the employee’s taxable salary is still reduced, any savings above the £2,000 cap will not attract further National Insurance relief. As a result, the employee may see a smaller increase in net take-home pay than under current rules.
What are the advantages of salary sacrifice arrangements for employers?
Salary sacrifice carries a range of benefits for employers. If you are considering introducing such a scheme for your employees, you could see the following advantages coming your way:
Cost-saving
When undertaken correctly, a salary sacrifice scheme will bring several cost-saving benefits to a company. By exchanging taxable income for non-cash benefits, both employers and employees reduce their National Insurance liabilities.
Increased employee satisfaction
A good paycheque isn’t enough for most employees. They want to be paid what they feel they are worth, but they also want to ensure that they get a good selection of benefits alongside their base pay. When employees are satisfied with their current benefits package, this will translate into their work through boosted productivity and engagement.
Talent attraction and retention
A robust benefits package, including good base pay and reasonable salary sacrifices, will be attractive to both current and potential employees. With these strong incentives, new talent will want to join your company, while current employees will want to stay with you and develop their skills and careers further.
What are the advantages of salary sacrifice schemes for employees?
As with any scheme in the workplace, employees need to see and understand their tangible benefits to opt in. You can have what you perceive to be the best benefits in the world, but if employees do not understand the value in them, they will never choose to opt for them. Employees can gain the following benefits through salary sacrifice schemes:
Tangible benefits
Some benefits are small intangible things behind the scenes that employees may not notice, even if they actively improve their experiences at work. High-value items, such as technology or bicycles, that may otherwise be unaffordable can be great perks that can make a real difference in their lives. New laptops, bikes, and mobile phones are all options that employees will truly appreciate.
Cost saving
The cost-saving aspects of salary sacrifice are not just for employers. Allowances for childcare, the latest tech, and other financial burdens can help to make these large costs a lot easier to manage. On top of this, the reductions in gross salary from sacrifice schemes will reduce their taxable income, therefore meaning they may have less tax and lower National Insurance contributions.
Futureproofing
Retirement can be a worry for many. A salary sacrifice arrangement can help employees put more towards their pensions, thus helping them build towards having adequate retirement savings.
Improved health and well-being
The right saving schemes can lead to an improvement in health and well-being throughout a company. Any stress about money can lessen, and this can lead to overall better health and well-being patterns.
Will the new cap on salary sacrifices affect pension savings?
In November 2025, the Chancellor, Rachel Reeves, confirmed changes to the tax treatment of salary sacrifice arrangements. As part of these reforms, a £2,000 annual cap on pension salary sacrifice schemes will be imposed from April 2029.
At the moment, companies do not pay a 15% employer National Insurance contribution on pension contributions made via salary sacrifice. From April 2029, however, the value of these National Insurance savings will be restricted by the £2,000 annual cap. Beyond this threshold, salary sacrifice will no longer deliver the same level of National Insurance efficiency for either employers or employees.
Under the new framework, and based on current (2025/26) National Insurance rates and bands, employees earning under £50,000 will face National Insurance at 8%, while those earning above £50,000 will pay 2% on amounts exceeding the cap. As a result, lower earners will be affected alongside higher earners.
With the salary sacrifice cap confirmed to take effect from April 2029, employers should begin preparing now by reviewing existing salary sacrifice agreements, pension contribution structures, and employee communications. Early planning will allow employers to manage any cost impacts, maintain engagement with pension saving, and ensure compliance once the new rules come into force.
Get your employee pensions in order with Spence & Partners
As an employer, you have the responsibility to ensure that your pension scheme offers the clearest information to employees. Increasing regulation and compliance risks put pressure on businesses to deliver the right schemes and support for all. With regulations and taxation due to change shortly, now is the time to gather expert advice and ensure your pension schemes are all in order.
Start a conversation with us today to optimise your current pension administration and give your employees the support they need, with or without salary sacrifice.
