Is Salary Sacrifice Worth it?

Salary sacrifice is a popular scheme in the UK that allows employees to exchange part of their salary for non-cash benefits, such as increased pension contributions, childcare vouchers, or a company car. But is it worth it? This article explores the pros and cons of salary sacrifice, how it works, and what to consider before deciding if it's right for you.

What is it?

Salary sacrifice, also known as salary exchange, is an arrangement between an employee and employer where the employee agrees to give up a portion of their salary in return for a non-cash benefit. The sacrificed salary is taken from the employee’s gross income (before tax and National Insurance contributions are deducted), which reduces their overall taxable income.

For example, if your gross annual salary is £30,000 and you decide to sacrifice £2,000 for additional pension contributions, your taxable income will reduce to £28,000. This can lead to tax and National Insurance savings for both the employee and employer.

What are the Benefits?

Salary sacrifice can offer various benefits, particularly in terms of tax efficiency. Here’s a breakdown of the main advantages:

1. Tax Savings

One of the main reasons employees choose salary sacrifice is for the potential tax savings. By reducing your gross salary, you reduce your taxable income. This means you will pay less Income Tax and National Insurance contributions. For example, if you are a basic-rate taxpayer (20%), and you sacrifice £1,000 of your salary, you could save £200 in Income Tax.

2. National Insurance Savings

Salary sacrifice also reduces the amount of National Insurance Contributions (NICs) you pay. For a basic-rate taxpayer, NICs are charged at 12%. Sacrificing £1,000 of your salary would save you £120 in NICs. Additionally, employers can also save on their NICs and may even pass these savings onto the employee in the form of increased benefits.

3. Increased Pension Contributions

Salary sacrifice is often used to boost pension contributions. In this scenario, the money you sacrifice is used to make additional contributions to your pension, which is highly tax-efficient. Many employers may also match or increase their contributions, making it an even more attractive option.

4. Flexibility of Benefits

In addition to pension contributions, salary sacrifice schemes can be used for a range of benefits, including:

• Cycle-to-Work schemes

• Childcare vouchers (for those already in the scheme)

• Electric cars (taxed at a lower rate due to low emissions)

• Private healthcare These benefits can offer savings on products and services that you may have needed to pay for anyway.

5. Employer National Insurance Savings

Employers also benefit from salary sacrifice schemes by saving on their National Insurance contributions. In some cases, employers pass these savings back to employees by increasing pension contributions or offering other perks.

What are the Drawbacks?

While there are clear financial benefits to salary sacrifice, it’s important to consider the potential downsides before deciding if it’s the right choice for you.

1. Reduced Gross Salary

Although salary sacrifice lowers your taxable income, it also reduces your gross salary. This could impact certain salary-based benefits, including:

• Statutory Maternity Pay (SMP)

• Statutory Sick Pay (SSP)

• Redundancy pay

• Mortgage applications, as lenders typically assess your income based on gross salary

2. Impact on State Pension and Benefits

Because salary sacrifice reduces your NICs, it could potentially affect your entitlement to certain state benefits, including the State Pension. If your salary falls below the NIC threshold (currently £12,570 for the 2024/25 tax year), you may lose out on National Insurance credits, which count towards your State Pension.

3. National Minimum Wage Restrictions

Salary sacrifice cannot reduce your income below the National Minimum Wage (NMW). If you’re a lower earner, this may restrict the amount you can sacrifice. Employers are required to ensure that employees’ post-sacrifice salary does not fall below the NMW.

4. Fixed Benefit Choices

The benefits you can receive through salary sacrifice are often pre-determined by your employer. While many schemes offer flexibility (e.g., pension contributions, cycle-to-work, and healthcare), you may not always be able to choose exactly how to use the sacrificed income.

Examples of Salary Sacrifice in Practice

• Pension Contributions: If you earn £50,000 and sacrifice £5,000 into your pension, your taxable income becomes £45,000. This reduces your income tax bill and National Insurance contributions, saving you money while boosting your pension pot.

• Cycle-to-Work Scheme: You could sacrifice part of your salary to obtain a new bike through your employer’s cycle-to-work scheme. The cost of the bike is spread over several months, and because your gross salary is reduced, you pay less tax and National Insurance.

• Electric Car Lease: Many companies now offer electric cars through salary sacrifice schemes. The savings from reduced tax and National Insurance contributions can make leasing a low-emission vehicle more affordable than buying or leasing one independently.

Is Salary Sacrifice Worth It?

Salary sacrifice can offer significant tax and National Insurance savings, making it a valuable option for many employees. However, the benefits depend on your personal financial situation and how the reduction in salary might impact your eligibility for other benefits, borrowing potential, or future state pension.

If you’re a higher earner, salary sacrifice may be particularly attractive as it can reduce your income below the higher tax threshold, increasing your overall savings. For basic rate taxpayers, the appeal lies in making more efficient pension contributions or taking advantage of other benefits.

Conclusion: Should You Choose Salary Sacrifice?

Whether salary sacrifice is worth it depends on your individual circumstances. If you’re looking to save on taxes and build your pension, it’s a smart move. However, if you’re planning to take out a mortgage or rely on certain state benefits, it’s essential to weigh the pros and cons carefully.

Before entering into a salary sacrifice arrangement, it’s a good idea to speak to a financial advisor or consult with your employer to ensure you’re making the best decision for your financial future.