Following the recent Budget announcement, from April 2025, Employer NI contributions are increasing by 1.2 per cent and the Lower Earnings Threshold is being lowered from £9,100 to £5,000.
Although the Employers Allowance is increasing from £5,000 to £10,500, the increase in cost could still be substantial to businesses.
Businesses will therefore be looking at ways to reduce this impact.
Salary sacrifice schemes, or – as we think they should be known – salary exchanges, provide an effective way to reduce employers NI contributions while also for employees boosting their pension contributions while potentially saving on their own tax and National Insurance (NI) contributions.
At its core, a salary sacrifice scheme allows an employee to exchange a portion of their salary for a non-cash benefit, such as a pension contribution.
Instead of the employee making personal contributions from their pre-tax income, the employer makes the entire contribution on their behalf.
As a result, the employee’s annual taxable income is reduced, which can also lower the amount of salary subject to NI.
This will obviously not suit all employees and any discussions around this could take place at the usual annual review. You may also consider offering a higher pension contribution rather than a salary increase.
How does salary sacrifice work?
Here’s a step-by-step look at how a salary sacrifice scheme operates:
- Agreement to reduce salary: The employee agrees to reduce their gross salary by a set amount, known as the ‘sacrifice.’
- Employer contributions: This sacrificed amount is then redirected by the employer into the employee’s pension fund as an employer contribution.
- Tax and NI savings: With a lower pre-tax salary, both the employee and employer reduce their NI contributions. Given the recent 1.2 per cent increase in Employer NI, this is a potential cost-saving opportunity for companies, and it offers employees greater pension savings with minimal impact on take-home pay.
In effect, the employee’s take-home pay is marginally lower, but they benefit from increased pension contributions and tax savings.
The benefits of salary sacrifice
Salary sacrifice schemes offer several advantages, especially in light of the recent Budget changes:
- Reduced NI contributions: Lowering the pre-tax salary reduces both employee and employer National Insurance contributions, helping employees keep more of their earnings and employers save on their NI liabilities. This is particularly beneficial given the rise in Employer NI, allowing both parties to manage their costs more effectively.
- Tax efficiency: Employees benefit from tax relief at the source, meaning there’s no need for higher-rate taxpayers to apply for additional relief. This simplifies tax planning and ensures employees maximise their tax benefits.
While salary sacrifice can be advantageous, there are key points employees should be aware of.
Impact on salary-based benefits
Opting for salary sacrifice results in a lower ‘on paper’ salary, which can affect benefits or financial products linked to income, such as:
- Life insurance
- Mortgage affordability assessments
- Statutory maternity or paternity pay
- Credit card borrowing limits
- Unemployment and disability benefits
Employees should consider whether a reduced salary could impact their financial obligations and long-term plans.
Employer-only contributions
Salary sacrifice contributions are classed as employer contributions.
While this doesn’t affect the pension savings themselves, employees not used to making personal contributions may need to consider how this change aligns with their long-term pension strategy.
Is salary sacrifice right for you?
In light of the recent rise in Employer NI, salary sacrifice schemes may be an attractive option for both employees and employers.
However, they’re not suitable for everyone.
Employees should carefully consider their financial circumstances, especially if they rely on benefits tied to their gross salary or have future borrowing needs.
