Contractor Pay Guide

First Off, What Exactly is Salary Sacrifice?

In a nutshell, salary sacrifice (sometimes called 'salary exchange') is an arrangement between you and your employer (in this case, often your umbrella company) where you agree to give up a part of your gross salary. In return, your employer pays that same amount directly into your pension.

The big win? Because that money goes into your pension *before* Income Tax and National Insurance (NI) are calculated on your salary, you don't pay tax or NI on the sacrificed amount. Your employer also saves on their Employer's NI contributions on that bit of salary too. It's a win-win for tax efficiency!

This is different from making a personal pension contribution from your net (after-tax) pay, where your pension provider then claims back basic rate tax relief from HMRC to add to your pot. With salary sacrifice, you get the tax relief upfront by not paying it in the first place.

Salary Sacrifice When You're Inside IR35 (via an Umbrella Company)

This is where salary sacrifice really shines for many contractors. If your contract is determined to be Inside IR35, you're likely being paid via an umbrella company. Many (but not all!) compliant umbrella companies offer salary sacrifice for pension contributions.

Here’s how it typically works:

• You agree with your umbrella company to sacrifice a certain amount or percentage of your gross contract value (after the umbrella's margin and other employment costs like Employer's NI are accounted for, but before your PAYE tax and Employee NI are calculated).
• The umbrella company then pays this amount directly into your chosen pension scheme.
• Your payslip will show a lower gross taxable salary, meaning you pay less Income Tax and Employee's NI.
• The umbrella also saves on Employer's NI, and some may pass a portion of this saving back to you by adding it to your pension contribution, further boosting your pot! It's worth asking if they do this.

This can make a significant difference to your overall take-home pay plus pension value compared to not using salary sacrifice. Have a look at our guides on Choosing Your Trading Structure and our Umbrella Payslip Explainer to see how these deductions fit into the bigger picture.

What About Pension Contributions When You're Outside IR35 (Limited Company)?

If you're operating Outside IR35 through your own limited company (PSC), the most common and tax-efficient way to contribute to your pension is usually through company (employer) contributions. Your company makes a payment directly from the business bank account into your personal pension scheme (like a SIPP).

These company contributions are generally treated as an allowable business expense, so they reduce your company's profit and therefore its Corporation Tax bill. It's a very powerful way to extract funds from your company tax-efficiently for your retirement.

While salary sacrifice *is* technically possible for a director of their own limited company, it's often less straightforward than simply making direct company contributions. The main benefit of salary sacrifice in a PSC context would be the National Insurance savings on the sacrificed director's salary, but many directors opt for a small salary and larger company pension contributions anyway.

For more details on how PSCs can make the most of pensions, see our guide on Pension Strategies for Contractors.

The Big Perks of Salary Sacrifice for IR35 Contractors

• Income Tax Savings: You're not taxed on the portion of your income you sacrifice. Simple as that.
• National Insurance Savings: You save on Employee's NI, and your employer (umbrella) saves on Employer's NI. This is a key advantage over just making personal contributions from net pay.
• Simplicity (usually): When it's set up through a good umbrella company, it's often quite straightforward. They handle the deductions and payments to your pension.

Anything to Watch Out For?

• Impact on 'Salary-Related' Benefits: Because salary sacrifice reduces your official gross salary, it *could* theoretically affect things like life cover or mortgage applications if they're based strictly on your P60 salary figure. However, for umbrella contractors, this is often less of an issue as the "assignment rate" is usually what's considered for affordability. Always best to check if you're concerned.
• Umbrella Company Practices: Make sure your umbrella company processes salary sacrifice correctly and transparently. Look for clear payslips.
• Pension Annual Allowance: Remember, there's a limit to how much you can contribute to your pension each tax year and still get tax relief (currently £60,000 for most people in 2025/26, but it can be lower for high earners or if you've accessed your pension flexibly). Salary sacrifice contributions count towards this allowance.
• National Minimum Wage: Your salary after sacrifice cannot fall below the National Minimum Wage or National Living Wage. Umbrella companies will manage this.