A Guide to Salary Sacrifice Schemes: Pensions, Cycle to Work, and More

Salary sacrifice is one of the best-kept secrets in small-business payroll. Set it up once, and both you and your employees save money. No complicated benefits portal. No payroll rework every quarter. Just lower tax bills and happier staff.

If you've got 1–25 employees and you're not yet offering salary sacrifice — particularly for pensions — you're basically leaving money on the table. This guide explains how it works, which schemes are worth your time, and how to implement it.

What is salary sacrifice?

Salary sacrifice (also called "salary exchange") sounds complicated, but the mechanic is straightforward: an employee agrees to swap part of their gross salary for a non-cash benefit. Because the benefit replaces salary rather than stacking on top of it, both of you pay less National Insurance.

Here's the simple version: the employee's contractual salary goes down by the value of the benefit. They get the benefit instead of that pay. Lower salary = lower income tax and employee National Insurance. You pay less employer National Insurance. Everyone's better off.

It's one of the few benefit structures where the employer actually saves money. Not "we're happy to invest in our people" — though you are. But genuinely, you pocket a saving.

How salary sacrifice actually works: the pension example

Pension salary sacrifice is by far the most common arrangement, and it's the one that makes the numbers sing. Instead of the employee contributing from their take-home pay (after tax), your business contributes directly from the sacrificed salary.

The old way (no salary sacrifice):

An employee on £30,000 per year wants to contribute £150 per month to their pension.

They contribute £150 from net pay (it's already been taxed once)
That £150 costs them £150 in cash
The pension scheme claims basic-rate tax relief and adds £37.50 (20%) to the pot
Total in the pension: £187.50 per month

The salary sacrifice way:

The same employee's salary drops to £29,812.50 per year (£187.50 monthly reduction). Your business pays that £187.50 directly into their pension.

Their gross salary is lower, so they pay less income tax and less employee National Insurance (save roughly £25 per month)
You pay less employer National Insurance on the reduced salary (save roughly £25.88 per month)
Total in the pension: £187.50 per month — same amount, but achieved for less cash all around

The employee's take-home is actually higher (because they dodge National Insurance). Their pension pot grows to the same level. And you've pocketed a real saving that many small-business owners reinvest into the employee's pension anyway, creating a win-win-win.

(If you want to be the good employer, you can pass your NI saving on to them. More on that later.)

Which benefits qualify for salary sacrifice?

Since April 2017, HMRC tightened the rules — mostly to prevent abuse. But a handful of benefits still get favourable tax treatment under the Optional Remuneration Arrangements (OpRA) rules. These are the ones worth your time:

Pension contributions. The heavyweight. Works with any qualifying workplace pension. Both you and the employee save National Insurance. This is where the real money is.

Workplace pensions and auto-enrolment rules are a separate topic, but salary sacrifice integrates neatly into that system. If you're auto-enrolling staff into a pension (which, for 1–25 employees, you almost certainly are), salary sacrifice is a natural next step.

Cycle to work. Employees sacrifice salary to lease a bicycle and cycling equipment under the statutory Cycle to Work scheme. Tax-free, NI-free. At the end of the lease, they can usually buy the bike at a reduced price. Popular in cities; less so in commuter towns.

Childcare vouchers (closed to new entrants). If you have employees on the old scheme, they can stay. No new applicants, though.

Ultra-low emission vehicles. Company cars with CO2 emissions of 75g/km or less (think: electric vehicles, plug-in hybrids) qualify for a dramatically lower benefit-in-kind tax rate under salary sacrifice. A Tesla costs less to your employees in tax than a 2-litre petrol car — on paper at least. Useful if your team needs vehicles.

Personal technology (laptops, tablets, phones). Some businesses offer this, but it doesn't carry the same tax advantages as the schemes above. It's taxed as a full benefit in kind. Skip this one unless you have a very specific reason.

Setting up a salary sacrifice scheme: the five-step process

Step 1: Choose which benefits to offer

For 90% of small businesses, that's pensions. Cycle to work is a nice add-on if your team cycles. Ultra-low emission vehicles are worth exploring if you're hiring (or replacing cars). Childcare vouchers only matter if you have staff on the old scheme.

Step 2: Change the employment contract

This is the bit HMRC cares about most. Salary sacrifice only counts if it's a genuine contractual change — not just a payroll adjustment, not a memo, not a verbal agreement. The employee must formally agree to a lower salary in exchange for the benefit.

Write an addendum (or a fresh contract clause) that spells out:

The amount of salary being sacrificed
What benefit they're getting in exchange
When it starts and ends
How they can opt out (usually annually, or on a "life event" like marriage or redundancy)

The Small Business Guide to Employment Contracts covers what goes into a contract generally; make sure your salary sacrifice amendment is clear and documented.

Step 3: Update payroll

This is where most payroll software either shines or falls apart. You need to reduce the employee's gross salary by the sacrificed amount and ensure that:

Income tax is calculated on the lower salary
Employee National Insurance is calculated on the lower salary
Employer National Insurance is calculated on the lower salary (this is where you save)
The pension contribution is applied to the sacrificed amount (for pension salary sacrifice)

A Beginner's Guide to Running Payroll for Your Small Business covers the payroll essentials; salary sacrifice is an advanced move, but a modern payroll system should handle it without drama.

Step 4: Arrange the actual benefit

For pensions, you typically just increase the employer contribution input by the sacrificed amount. For cycle to work, you'll set up a lease agreement with a scheme provider (companies like Cyclescheme, BikeiBike, or others handle the admin). For vehicles, you'll work with a car-leasing company.

Step 5: Communicate clearly

Your employees need to know what's happening and why. Explain:

What salary they're giving up
What benefit they're getting in exchange
How their take-home changes (will likely be higher, due to NI savings)
What happens if they want to opt out
Any impacts on statutory payments or other calculations (more on that below)

A badly explained salary sacrifice scheme is an employee-relations nightmare. A well-explained one is a genuine morale booster. Spend the time on communication.

Watch out for: National Minimum Wage and statutory payments

Salary sacrifice sounds straightforward until it bumps into other employment law.

National Minimum Wage. Your employee's cash pay (after sacrificing salary for the benefit) must not fall below the National Minimum Wage. If sacrificing £200/month would push someone below minimum wage, you can't do it. HMRC and the Insolvency Service take this seriously.

Statutory Maternity Pay, Statutory Sick Pay, and other earnings-based entitlements. These are calculated on actual earnings. If an employee sacrifices salary, their SMaP, SSP, and similar payments are lower. This can be a genuine hardship if someone goes on maternity or sick leave. Some businesses mitigate by using the pre-sacrifice salary ("reference salary") for calculating these entitlements, which requires a separate contract clause. The Employer's Guide to UK Statutory Leave Entitlements covers these in detail.

Mortgage and insurance applications. Lenders and insurers look at gross salary. A lower salary might affect a mortgage approval or an insurance quote. Employees need to know this.

Death-in-service benefits. If your business-owned life insurance calculates payout as "three times salary," a sacrificed salary will reduce the payout. This is often overlooked and causes resentment. Use a reference salary or communicate it clearly upfront.

The Employer's Guide to National Insurance Contributions has more detail on how NI interacts with payroll structures; salary sacrifice is part of that picture.

The economics: why this matters for small businesses

Salary sacrifice on pensions is one of the few moves that actually saves you money while improving your employee benefit offering.

Run the numbers: if you have 20 employees each sacrificing £200 per month (£2,400 per year) into a pension, your employer National Insurance saving is roughly £6,600 per year at the current 13.8% rate. That's real money for a business with 20 staff.

Many small-business owners use that saving to:

Boost the pension contribution further (turn your £200 saving into £250 into their pension, at no net cost to you)
Fund the admin overhead of the scheme
Simply reduce overall employment costs

From an HR perspective, offering salary sacrifice signals that you're serious about helping your employees' financial future. It's a relatively low-friction way to offer a genuine, valuable benefit — one that shows up in their personal finances every month.

Implementing with your payroll system

Your payroll platform needs to handle:

Reducing gross salary by the sacrificed amount
Recalculating tax and NI on the lower salary
Applying the employer contribution (for pensions)
Tracking start and end dates for the arrangement
Reporting correctly through RTI to HMRC

Most modern platforms — including Relentify — build salary sacrifice into the standard payroll workflow. Set it up once, and it processes automatically each pay period. No spreadsheet workarounds. No manual recalculation.

Frequently Asked Questions

Q: Does salary sacrifice affect the employee's state pension?

A: No. Their state pension is based on their National Insurance record, which is still credited even when they're salary-sacrificing. Their state pension entitlement does not change.

Q: Can an employee opt out of salary sacrifice?

A: Yes. The contract should specify opt-out windows (usually annually, or on a life event). An employee can't be forced to stay in the scheme. Build this into your contract from the start.

Q: What if an employee is already making pension contributions; can they move to salary sacrifice?

A: Yes. You'd typically align the contributions (ensure the salary-sacrificed amount matches or exceeds what they were already contributing) and then cease the net-pay contributions, switching to gross-pay employer contributions instead. The pension provider can usually handle this swap.

Q: Is salary sacrifice more expensive to administer than regular payroll?

A: Not materially. Most payroll software handles it as a standard input — no additional complexity. The main cost is the upfront legal review of your contract amendment.

Q: What happens if an employee goes on maternity or sick leave while in salary sacrifice?

A: Statutory Maternity Pay and Statutory Sick Pay are calculated on their actual salary (the sacrificed amount). This can be a genuine hardship. To mitigate, you can use a pre-sacrifice "reference salary" for these calculations, but you must specify this in the contract and ensure payroll tracks it. Some businesses choose to pause salary sacrifice during maternity leave for this reason.

Q: If I offer salary sacrifice for pensions, do I have to offer it for other benefits?

A: No. You can pick and choose. Most small businesses start with pensions only. Cycle to work is a common second addition.

Q: What happens to salary sacrifice if an employee leaves?

A: The arrangement ends. If they've opted in and then left, the scheme ceases. There's no ongoing obligation. If they join a new employer, they'd need to opt into a new salary sacrifice scheme at that business (it doesn't carry over).

Q: Does salary sacrifice affect mortgage applications or credit checks?

A: It can, indirectly. Mortgage lenders assess affordability based on gross salary, and a lower salary (even if take-home is higher) might affect lending decisions. Employees should disclose the arrangement when applying for mortgages, loans, or credit. Some lenders ask for proof of the reference salary or full earnings history.

Key takeaways

Salary sacrifice is a tool you can set up once and forget about (mostly). It saves both you and your employees money. Pensions are the obvious place to start. A genuine contract change is non-negotiable for HMRC compliance. Watch the impacts on National Minimum Wage, statutory payments, and other earnings-linked calculations. And for small businesses, the employer National Insurance saving alone often justifies the effort.

If you're not yet offering salary sacrifice for pensions, it's worth a conversation with your payroll provider or an employment specialist. The setup is straightforward, and the saving is real.