In March 2023, HM Revenue and Customs (HMRC) commissioned IFF Research to undertake research to understand the experiences, motivations, and attitudes of employers towards using salary sacrifice arrangements for pensions.
The research also explored whether hypothetical changes to tax reliefs (such as reform of NICs relief) on pension salary sacrifice arrangements may impact employers’ motivations and attitudes towards these arrangements.
So what is salary sacrifice?
Salary sacrifice is a type of Optional Remuneration Arrangement (OpRA) whereby an employee agrees to give up part of their pre-tax salary in exchange for a benefit from their employer.
Sometimes they have alternate labels which same may suggest are not salary sacrifice when in reality they are. Such arrangements may be referred to as Flex or flexibility and others may refer to them as smart or salary exchange – these are all a form of salary sacrifice arrangement. Sometimes there is reference to buying of benefits in description yet the contractual arrangement is a lay but fir a free of charge benefit in kind.
Common benefits utilised via a salary sacrifice mechanism include pensions arrangements, childcare provisions and access to a bike via the Cycle to Work Scheme.
National Insurance savings
When asked about the motivations to offer salary sacrifice for pensions, employers noted that it was generally seen as beneficial for both the employer and their employees.
The most common reason reported for offering employee pensions through a salary sacrifice arrangement were the NI savings for both the employer and their employees, and that most of their employees took up the offer.
It was considered that salary sacrifice arrangements added to the overall package they could provide to employees. Employers said this was due to the NI savings the employee could make from the salary sacrifice pension arrangement, and, in some cases, where employees could also receive higher employer pension contributions as a result of employers also contributing their NI savings.
Some employers explicitly said the NI savings did not go towards anything in particular, although others whilst some said they do pass on their employer NI savings from salary sacrifice to their employees by increasing the employer pension contributions.
National Minimum Wage
Many employers said that employees could vary the amount of salary sacrificed, so long as their take-home pay still met the National Minimum Wage.
With ever increasing minimum wage rates, the risk of breach via salary sacrifice has significantly increased.
Salary sacrifice arrangement always reduce NMW earnings, yet genuine employee contributions do not.
Are they easy?
Generally, employers reported that those that offer them found salary sacrifice easy to explain to their employees and easy to administer.
However, some of the findings suggested that there could be limited understanding among some employers about how they work.
The operation of effective salary sacrifice and pension rights can be complicated and misunderstood. Terminology on pension tax reliefs are confusing which adds layers of complexity, however salary sacrifice provides an aligned treatment independent of a scheme being in the Net Oay Arrangement (NPA or Net scheme) which apply employee pension contributions before tax, versus Relief At Source (RAS) which apply employee deductions after tax.
The catch!
However, there are catches that some employers do not appear to have picked up on or covered by this report. Under Social Security regulations, the enhanced employer contribution that result from salary sacrifice arrangements have traps when it comes to statutory parental leave periods as the employer cannot sacrifice any statutory payment, yet parental and maternity protections require full enhanced employer contributions as if still receiving full pay.
What if NI rules changed – The scenarios
As part of the research, some scenario testing was undertaken in relation to the treatments for National Insurance.
Scenario 1 – no NIC relief
This scenario removed the NI exemption for salary sacrifice pensions, which would result in employer and employee NI charges on the salary the employee sacrificed.
Where employers understood the scenario correctly, they responded negatively, any benefit of salary sacrifice would be removed.
Scenario 2 – no NIC or tax relief
This scenario removed the NI exemption for employers and employees, and the income tax exemption for employees,
These NI and income tax charges would only affect contributions provided through salary sacrifice. Any employer contributions provided outside of salary sacrifice would continue to be exempt from income tax and NI.
This scenario would not impact overall pension relief provided for employee contributions which would continue to be exempt from income tax using other pension mechanisms.
Employers responded most negatively to this scenario. This would negate any benefit in salary sacrifice arrangements.
Scenario 3 – NIC relief on amounts up to £2,000
This scenario removed only the NI exemption for salary sacrifice pensions beyond a threshold of £2,000 per year. This would mean that employers and employees would not need to pay NI on any salary sacrificed up to £2,000 but would need to pay NI on any salary sacrificed above.
Most employers were still concerned that this scenario resulted in a reduction of benefits. The effectiveness of salary sacrifice would be limited.
The missing scenario – NI relief on employee contribution
What wasn’t tested were the attitudes to a change to employee pension contribution additionally attracting NIC reliefs in similar way to the Income Tax Net Pay Arrangement.
How simple would things become if an employee could make contributions with both tax and NIC reliefs.
If such a change was progressed, then the consequence would be that as true employee contributions as opposed to salary sacrifice arrangements, that reductions to NMW earnings would no longer apply as they are allowed.
What this would do is put standard employee contributions on equal footing with salary sacrifice arrangements.
What’s the benefit to employee of salary sacrifice pensions?
Many employers offering salary sacrifice reported that they felt their overall pension offering had a positive impact on employee retention, that salary sacrifice added to the overall package they could provide employees.
Are there alternates to consider?
PAYadvice thoughts, which have been expressed to HM Treasury and HMRC representatives, is that the need for salary sacrifice use for pensions could be eliminated altogether by legislating for an equal relief mechanism that covers both Tax and National Insurance. That contributions reduce the NI gross value regardless.
The advantage would be that any corresponding impact on National Minimum Wage regulations would consequently be eliminated as there would no longer be a salary sacrifice cut in pay which impacts NMW but a genuine employee pension contributions that qualifies for both tax and NIC reliefs. As a now genuine employee contribution it has no impact on NMW pay.
Want to know more?
The full report can be found at:
PAYadvice.UK 19/6/2025