Pension contribution methods can be confusing, and the way tax relief is applied varies depending on the method your employer uses. In fact, recent research shows that over 40% of UK employees don’t fully understand how their pension contributions affect their take-home pay, making it harder to plan for the future.
Tax relief is a government mechanism that aims to boost pension contributions of UK employees. Every employee who earns over a stipulated amount is obligated to pay income tax. However, if employees choose to put that money into their pension, the tax that would normally be paid is added to their pension instead.
In this article, we’ll break down the three main workplace pension contribution methods – net pay, relief at source, and salary sacrifice – and explain which one is better in different scenarios.
Table of contents
Definitions at a glance
- Relief at source: Contributions are deducted after tax. The pension provider claims basic-rate tax relief (20%) for the employee which goes into the employees’ pension pot
- Net pay: Pension contributions are deducted before tax, so employees get automatic tax relief. This means their income tax relief at their marginal rate of tax is put straight into their pension.
- Salary sacrifice: Employees agree to reduce their salary in return for the employer covering the cost of the employees’ pension contribution. The pension contribution is taken as a pre-tax deduction. Saves both income tax and National Insurance for employees, while employers can also save on NI.
How pension relief at source works
Relief at source refers to an arrangement where employee contributions are deducted after tax. The pension provider then claims 20% basic rate tax relief from HMRC and adds it to the employees’ pension pot. This means employees still benefit from government tax relief even if they pay little or no income tax.
Who benefits most
Relief at source is most suitable for lower earning employees, especially those earning below the personal allowance (~£12,570 in 2025/26). This option is ideal because they automatically receive 20% basic-rate tax relief, even if they pay no income tax.
However, higher rate and additional rate taxpayers can still claim extra tax relief through manual self-assessment if relief at source is the chosen arrangement.
Things to consider
- All employees benefit from basic-rate relief: Everyone gets at least the 20% government boost added to their pension contributions. In the case of higher-rate taxpayers, they will need to take additional action to receive their full relief.
- Contributions are deducted after tax: Unlike net pay, taxable income isn’t reduced, so employees’ tax is calculated on their full salary. The pension provider then adds basic-rate tax relief to their pension pot.
How net pay pensions work
In a net pay arrangement, pension contributions are taken from your employees’ pay before tax is calculated, meaning their taxable income is lower and they automatically receive tax relief through payroll.
Who benefits most
Higher-rate (40%) and additional-rate (45%) taxpayers usually get the most benefit from a net pay arrangement. Contributions are deducted before tax, so they automatically receive the full tax relief without having to submit a self-assessment tax return.
Things to consider
- National Insurance is unaffected: Employees still pay NI on their full salary, so there’s no NI saving for either the employee or employer under net pay.
- Low earners may miss out: Employees earning below the personal allowance (£12,570 in 2025/26) won’t benefit from tax relief, since they have no income tax to reduce.
How pension salary sacrifice works
In a salary sacrifice arrangement (also known as salary exchange), an employee agrees to reduce their salary by the amount they want to contribute to their pension. Their employer then pays that amount directly into their pension as an employer contribution.
Salary sacrifice is different to net pay and relief at source arrangements in that it generates both tax & NI savings for the employee. Your organisation will also save on NI, which can be passed back to employees as extra pension contributions.
Who benefits most
Oftentimes, salary sacrifice is the most efficient tax option to take for employers as it benefits the majority of the workforce. Here’s how salary sacrifice can apply to each taxpayer band:
- Basic rate taxpayers: Pension contributions that are sacrificed (or exchanged) reduce income tax and save on NI, meaning take home pay is higher than a net pay or relief at source arrangement
- Higher rate taxpayers: Income tax and NI are reduced in the same way as a basic rate taxpayer. Salary sacrifice can also help higher rate taxpayers keep their salary below the high-income threshold, potentially increasing tax savings even further.
Things to consider
- Employees pay no income tax or National Insurance on the sacrificed amount
- Employees’ take-home pay increases slightly compared to making a standard pension contribution
- Employers can opt to top up employee pensions further using the National Insurance savings they make
- Salary sacrifice can affect benefits linked to gross salary, such as maternity pay or life insurance
- Low earners can make NI savings. However this only applies if their post-sacrifice salary is above the national minimum wage. Also, employees earning below the personal allowance (£12,570 in 2025/26), won’t benefit from income tax savings. For those in this bracket, Relief at Source may provide a better return, as they can still receive 20% government tax relief added to their pension (and this is likely to be higher than the 8% saving available through salary sacrifice).
To learn more about how salary sacrifice works: see our comprehensive guide here
Comparison table: relief at source vs net pay vs salary sacrifice
| Salary | Pension (5%) | Income tax (40%) | NI (2%) | Tax claimed back | Pension contribution split | |
|---|---|---|---|---|---|---|
| Relief at source | £60,000 | £2,400 (4% – paid to pension) £600 (1% – paid in tax & claimed back by pension provider) | £10,832 | £3,210.16 | £600 (Through self-assessment claim) | 4% employee 1% tax relief pension provider 3% employer |
| Net pay | £60,000 | £3,000 | £10,232 | £3,210.16 | 5% employee 3% employer | |
| Salary sacrifice | £60,000 | £3,000 | £10,232 | £3,150.60 | 0% employee 8% employer |
Key takeaways:
- Employees pay more tax upfront with relief at source, however can claim it back via self-assessment
- With relief at source, employees only see 4% deducted from their payslip but actually benefit from a 5% contribution overall once government tax relief is added
- Employees using salary sacrifice pay less NI in a tax year compared to a net pay arrangement – therefore increasing their take home pay
- With salary sacrifice, employees don’t need to reclaim tax relief separately – it’s automatically applied through payroll
Tax relief limits
It’s important for employers and employees to be aware of pension tax relief limits:
- Annual allowance: Employees can receive tax relief on pension contributions up to £60,000 per year (2025/26), including both employee and employer contributions. Contributions above this limit may incur a tax charge.
- Lifetime allowance: There’s also a lifetime limit on pension savings, currently £1,073,100, above which additional tax may apply.
- High earners: Employees with incomes over £240,000 may face a tapered annual allowance, reducing the tax-efficient contribution limit.
Understanding these limits helps employees maximise tax relief without unexpected charges and allows employers to design pension offerings effectively.
Tips for employers
No matter which option you choose for your employees, here are some guidelines on how to make sure your workforce understand their benefit and maximises their pension and tax situation:
- Communicate clearly: Explain your chosen arrangement clearly so employees understand how it benefits their pension and affects their take home pay.
- Understand compliance and responsibilities: Ensure that each scheme complies with legal requirements, including minimum salary thresholds, National Insurance calculations, and any impacts on benefits linked to gross pay (e.g., maternity pay or life insurance).
- Highlight benefits for different groups: Make sure employees know which arrangement suits them best. Low earners may benefit more from relief at source, while higher-rate taxpayers and those using salary sacrifice can maximise tax and NI savings.
- Leverage expert support: Consider enlisting the services of a financial wellbeing provider to help manage the administrative side of pension contributions, reduce errors, and provide guidance to employees.
Conclusion
Choosing the right pension contribution method can have a significant impact on employees’ take-home pay, long-term savings, and overall financial wellbeing. Net pay, relief at source, and salary sacrifice each have benefits depending on the employee group, but salary sacrifice often provides the most tax-efficient solution for both employers and employees.
Clear communication, understanding compliance responsibilities, and providing support for employees are key to ensuring any scheme succeeds. When implemented thoughtfully, a well-managed pension arrangement not only helps employees make the most of their contributions but also strengthens your benefits strategy and supports financial security across your workforce.
If you want expert guidance to implement and manage salary sacrifice effectively, Maji can help you make it simple, compliant, and impactful for your team. Book a call here today.
