In the face of rising living costs and escalating employer expenses across the UK, a decades-old strategy is finding new life as a tool to boost retirement savings while preserving — and even enhancing — take-home pay.
Scottish Widows Workplace Savings Specialist Susan Hope told Yahoo Finance UK that salary sacrifice — also known as salary exchange — is a “pensions fairy tale,” highlighting how it generates savings for both employees and employers.
Hope wasted no time in dispelling common misconceptions. “We need to stop calling it salary sacrifice because sacrifice implies loss,” she said.
Instead, she prefers the term salary exchange. “It’s exactly that, an exchange, and employees agree to forgo a portion of their gross pay, their salary before tax and national insurance, in return for an employer pension contribution.”
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By restructuring how contributions are made, salary exchange allows money to bypass deductions on pay slips, which in turn avoids tax and national insurance contributions. In doing so, employees not only boost their pension pots but also enjoy savings that can manifest as increased net pay.
For employees, salary sacrifice works by reducing an employee’s gross salary, lowering their taxable income. This reduction can lead to an increase in take-home pay, as the employee benefits from lower tax and national insurance contributions. Alternatively, the savings from these reduced deductions can be redirected into the employee’s pension, increasing their pension contributions at a higher effective rate.
Hope said for an employee earning an average UK salary of £35,000, it works out to an extra £140 a year — an amount that may seem modest in the short term but accumulates to an impressive £20,000 over 25 years if directed into a pension and reinvested.
Beyond boosting long-term retirement savings, this method also offers immediate benefits. For example, reducing one’s gross salary through salary sacrifice, or salary exchange, can lower student loan repayments and avoid pitfalls such as the high-income child benefit tax charge or the loss of personal allowance that begins when earnings exceed £100,000.
Moreover, by receiving the correct rate of tax relief directly in their pay, higher-rate taxpayers no longer need to go through the administrative hassle of reclaiming the extra relief each January — a simplification that can save both time and stress.
Employers facing increased national insurance contributions — set to rise from 13.8% to 15% in April 2025 — and a concomitant rise in the national living wage, are under constant pressure to manage costs. Here, salary exchange presents an appealing option.
