What is Salary Sacrifice?

Salary sacrifice is an arrangement between an employee and their employer where the employee agrees to give up a portion of their salary in exchange for non-cash benefits. It is a widely used method in the UK to reduce taxable income while benefiting from perks like pension contributions, cycle-to-work schemes, or childcare vouchers. By reducing gross salary, both the employee and employer can potentially pay less in National Insurance (NI) and, in some cases, less income tax.

How Does it Work?

In a salary sacrifice arrangement, an employee agrees to a reduction in their salary, and in return, the employer provides a benefit of equal value, such as enhanced pension contributions, a company car, or healthcare benefits. This adjustment is made before tax and National Insurance are applied, meaning the employee is taxed on a lower income.

For example, if your annual salary is £30,000, and you agree to sacrifice £2,000 for additional pension contributions, your taxable salary will be reduced to £28,000. This can result in savings on income tax and National Insurance contributions.

What Are the Benefits?

Salary sacrifice arrangements offer several benefits, making them an attractive option for both employees and employers:

1. Tax Efficiency

By reducing your salary, you also reduce the amount of tax and National Insurance you pay. Since the sacrificed amount is deducted before tax, you are taxed on a lower salary, potentially moving into a lower tax bracket or simply reducing the total tax paid.

For example:

• A basic-rate taxpayer sacrificing £1,000 could save 20% (£200) in income tax and 12% (£120) in National Insurance.

• A higher-rate taxpayer might save 40% (£400) in income tax and 2% (£20) in National Insurance.

2. Increased Employer Contributions

In many cases, employers may pass their own National Insurance savings onto the employee by enhancing the benefits offered. For instance, if the employer saves National Insurance from a pension contribution, they may choose to increase their contributions to the employee's pension pot.

3. Flexible Benefits

Salary sacrifice schemes can be tailored to meet different needs. Common salary sacrifice schemes include:

• Pension contributions: A common use, particularly when the employer offers to match contributions.

• Childcare vouchers: Although this scheme has been replaced by Tax-Free Childcare, employees who joined before October 2018 can still use it.

• Cycle-to-Work schemes: Allows employees to get a tax-efficient bike for commuting.

• Car leasing schemes: You can get a tax-efficient company car, although this depends on the type of car, especially ultra-low emission vehicles.

What Are the Drawbacks?

While salary sacrifice has its benefits, there are a few potential downsides to consider:

1. Reduced Take-Home Pay

By reducing your salary, your monthly take-home pay will be lower. While the tax savings may offset some of this, you should ensure that the benefits outweigh the immediate reduction in income.

2. Impact on Benefits

Since salary sacrifice reduces your official salary, it could affect salary-based benefits, such as:

• Statutory Maternity Pay (SMP)

• Statutory Sick Pay (SSP)

• Redundancy payments

• State Pension contributions

These benefits are calculated based on your gross salary, so reducing it could lead to lower entitlements.

3. National Minimum Wage

Salary sacrifice cannot reduce an employee’s salary below the National Minimum Wage (NMW). Employers must ensure that after the sacrifice is applied, employees are still paid above the legal minimum wage threshold.

Types of Schemes

Several benefits are commonly offered through salary sacrifice in the UK. Some popular options include:

1. Pension Contributions

Salary sacrifice for pensions is one of the most common schemes. Instead of taking salary and then making pension contributions, you can sacrifice some salary, and your employer makes additional contributions on your behalf. This allows for tax-efficient pension saving.

2. Cycle-to-Work Scheme

This scheme allows employees to hire a bike for commuting through their employer. You can save on both the cost of the bike and the tax and National Insurance you'd otherwise pay on the salary used to purchase the bike.

3. Car Leasing Schemes

Employees can lease a car through salary sacrifice, and savings are dependent on the car’s CO2 emissions. Ultra-low emission vehicles (ULEVs) still benefit from reduced Benefit-in-Kind (BIK) tax, making it a tax-efficient choice.

4. Childcare Vouchers

This scheme, now closed to new entrants, allows employees who joined before October 2018 to exchange a portion of their salary for childcare vouchers, providing tax and National Insurance savings.

How to Set Up a Salary Sacrifice Scheme

To set up a salary sacrifice scheme, employers and employees need to agree on the terms. Here's how it works:

1. Negotiate with Your Employer: Discuss which benefits are available under a salary sacrifice scheme. Ensure that both parties agree on the salary sacrifice amount and the benefits being offered.

2. Contractual Agreement: An amendment to the employment contract is needed to reflect the agreed salary reduction. Both employee and employer must sign this agreement.

3. Implement the Scheme: The salary reduction is applied, and the benefits start. Employers may notify HMRC about any changes, particularly if the benefits affect National Insurance or tax contributions.

Salary Sacrifice and National Insurance Savings

One of the main ways salary sacrifice helps employees save money is through National Insurance contributions. National Insurance is calculated based on your gross salary, so reducing your salary through sacrifice lowers the amount of NI you pay. The same applies to your employer, who also saves on their NI contributions.

For example, if you agree to sacrifice £2,000 per year towards your pension, and you're a basic-rate taxpayer, you’ll save £240 in National Insurance (12%). Your employer will also save £276 (13.8%) on their contributions.

Is it Worth It?

Salary sacrifice schemes can be an excellent way to reduce your tax and National Insurance contributions while receiving valuable benefits like pension contributions, bikes, or even cars. However, it's essential to weigh the pros and cons. While you can benefit from lower taxes, sacrificing too much salary could impact your entitlement to state benefits and may lower your take-home pay.

Before committing to a salary sacrifice scheme, you should carefully consider your financial situation and future plans, ensuring that any arrangement works in your favour. Consulting with a tax professional or financial advisor may also help you make the best decision based on your circumstances.