Salary Sacrifice: When Giving Up Gross Pay Leaves You Better Off

Salary sacrifice is a contractual reduction in gross pay in exchange for a non-cash benefit, usually a pension contribution. Because the reduction happens before tax and social contributions are calculated, the employee avoids both on the sacrificed amount, and in most systems the employer avoids its share as well.

The arithmetic is unglamorous and unusually favourable. It is also the single most effective lever available to an ordinary employee at a high marginal rate.

What it saves, at each rate

The table shows a British employee sacrificing part of salary into a pension, and what the sacrifice costs in take-home pay.

Salary	Sacrificed	Net pay before	Net pay after	Real cost of the contribution
£45,000	£5,000	£35,920	£32,320	£3,600 (72.0%)
£55,000	£5,000	£42,457	£39,520	£2,937 (58.7%)
£60,000	£10,000	£45,357	£39,520	£5,837 (58.4%)
£90,000	£10,000	£62,757	£56,957	£5,800 (58.0%)

At a 42% marginal rate, every pound sacrificed costs 58 pence of take-home pay. The remaining 42 pence was going to income tax and National Insurance regardless. Nothing has been given away; the destination of part of the salary has been changed.

The first row shows why the same arrangement is far less compelling lower down. At £45,000 the marginal rate is 28%, so five thousand pounds of pension costs three thousand six hundred pounds of take-home pay rather than under three thousand. Identical contribution, identical scheme, seven hundred pounds of difference, decided entirely by which side of £50,270 the salary sits.

The exceptional case sits between £100,000 and £125,140, where the UK withdraws the personal allowance at £1 for every £2 earned. Sacrificing income out of that band relieves tax at an effective 60%, so £10,000 into a pension costs around £4,000 of take-home pay. The mechanism is set out in the £100,000 tax trap, and it is the clearest example anywhere of why the marginal rate, not the effective rate, decides what a contribution is worth.

The employer side

Employer National Insurance, currently 15% in the UK, is also avoided on sacrificed salary. Many employers pass some or all of that saving into the pension, which improves the trade further. On a £5,000 sacrifice a full pass-through adds £750 to the contribution at no cost to the employee.

It is worth asking directly whether the employer shares the saving. A significant number do not, and a significant number will if asked, because the alternative is keeping money they only have because you gave something up.

What else can be sacrificed

Pension contributions. The main event, and the one with the largest limits.
Electric company cars. Benefit in kind rates on fully electric vehicles remain low, which makes the arrangement genuinely efficient rather than merely neutral.
Cycle to work schemes. Small amounts, capped, and simple.
Additional annual leave. Buying holiday out of gross pay rather than net.
Childcare and workplace nursery arrangements. Narrower than they used to be, but still available in specific forms.

What cannot be sacrificed is anything that would take pay below the national minimum wage, which is a hard legal floor rather than a guideline.

The equivalents outside the UK

The mechanism has different names and different limits elsewhere, but the principle survives almost everywhere.

Country	Arrangement	Broad limit
Germany	Betriebliche Altersvorsorge (Entgeltumwandlung)	8% of the pension contribution ceiling, half of it free of social contributions
Ireland	Employee pension contributions	Age-related, from 15% under 30 up to 40% at 60 and over, on earnings capped at €115,000
Netherlands	Employer pension scheme contributions	Set by the scheme, deducted before Box 1 tax
Australia	Salary sacrifice to superannuation	Concessional cap of A$30,000 including employer contributions, taxed at 15% going in
United States	401(k) elective deferrals	Annual deferral limit, reduces federal income tax but not FICA
Canada	Group RRSP through payroll	18% of prior year earned income up to the annual limit

Two details in that table matter more than they look. American 401(k) deferrals reduce income tax but not Social Security or Medicare, so the saving is smaller than the headline rate implies. German Entgeltumwandlung reduces social contributions as well as tax, which is why it is worth considerably more to a mid-earner there than the equivalent is to an American one.

When it is a bad idea

Four situations where sacrificing salary costs more than it saves.

When it reduces a benefit calculated on gross pay. Statutory maternity pay, redundancy entitlements, mortgage affordability assessments and some life cover schemes are all based on gross salary. Sacrificing can quietly shrink all of them.
When you need the money. Pension contributions in most countries cannot be accessed until a set age. A contribution that leads to expensive short term borrowing is a poor trade at any marginal rate.
At a low marginal rate. Relief at 20% is far less compelling than relief at 42% or 56%, and in some systems contributing at a low rate now to draw taxable income later is close to a wash.
When it crosses a means test the wrong way. Rare, but student loan repayments in the UK are calculated after salary sacrifice while Australian HELP repayments are calculated before it, which produces opposite answers to the same question.

Model it directly. Enter your salary, then your salary minus the contribution, in the UK Salary Calculator or the Germany Salary Calculator. The difference between the two net figures is the real cost.

Related: What £50,000 leaves after tax