What is salary sacrifice?
Salary sacrifice is a government backed scheme designed to help employers and their workers save on tax. An employee agrees, with their employer, to give up part of their salary in exchange for non-cash benefits.
This means that the employee's gross salary is reduced by the amount they sacrifice. The result is lower National Insurance contributions (NICs) for both the employee and employer.
Employers can set up a salary sacrifice arrangement by changing the terms of an employee’s employment contract. The employee needs to agree to this change.
Today, only 41% of small and medium enterprises offer salary sacrifice, compared with 85% of large organisations. Salary sacrifice represents a simple way to trim tax and help employees keep more of what they earn.
What are the benefits?
Employee benefits of salary sacrifice
- Lower National Insurance contributions: Salary sacrifice can result in lower National Insurance contributions for employees. This can help employees keep more of what they earn.
- Lower tax liability: An employee can lower their income tax liability by reducing their gross salary. This means employees can potentially save money on their tax bill.
- Access to non-cash benefits: Salary sacrifice allows employees to receive non-cash benefits. These may include benefits they might not be able to afford otherwise.
Employer benefits of salary sacrifice
- Increased employee satisfaction: Offering salary sacrifice arrangements can help increase employee satisfaction and retention. Employees usually view the benefit as a valuable perk.
- Reduced National Insurance: Employers can pay less tax by saving money on their National Insurance contributions. Tax does not need to be paid on the salary that is sacrificed.
- Improved recruitment: Offering salary sacrifice arrangements can help attract and retain top talent. It's often seen as a key part of a competitive benefit package for job hunters.
What non-cash benefits can be used?
There are a variety of non-cash benefits that can be used for salary sacrifice. Some of the most common benefits include:
- Pension contributions: Employees can sacrifice a portion of their salary to contribute to their pension pot. This can result in lower tax and National Insurance contributions.
- Childcare vouchers: These can be used to pay for registered childcare. Vouchers can be received tax-free up to a certain amount each year.
- Cycle-to-work schemes: Employees can sacrifice part of their salary to buy a bike and cycling accessories.
- Technology equipment: This can include laptops, tablets, and smartphones. These can be used for work purposes and are often provided tax-free or at a reduced cost.
- Company car schemes: Some employers may offer salary sacrifice schemes for car ownership. The car is usually leased by the employer on behalf of the employee.
Workplace pension schemes
One of the most common methods employers take advantage is by making salary sacrifice contributions into employees auto enrolment pensions.
Traditionally an employer and employee pays a portion of earnings into a pension every month. With salary sacrifice the employee is paid less on the agreement that any money they sacrifice goes straight into their pension.
They are reducing their monthly take-home pay now in exchange for more money in their pension for the future.
The benefit is that by reducing the money they receive right now, they owe less tax. Therefore they get to keep more of what they earn overall.
Penfold offer free, bespoke, salary sacrifice consultations. We help businesses understand how they can take advantage of a tax efficient pension scheme.
Examples of salary sacrifice
Monthly employee pension contributions
- Salary: £2,500 per month.
- Salary sacrificed: £125 per month.
- Non cash benefit received: £125 employer contribution to pension scheme.
- Result: Employee take home pay increased by £15 per month due to reduced NI contribution. Employer NI contribution reduced by £17 per month per employee.
One off bonus pension contribution
- Salary: £5,000 cash bonus.
- Salary sacrificed: £5,000.
- Non cash benefit received: £5,000 employer contribution to pension scheme.
- Result: No employment income tax or National Insurance contributions charge to the employee. The full amount is invested in the pension.
Weekly childcare vouchers
- Salary: £350 per week.
- Salary sacrificed: £50 of that salary.
- Non cash benefit received: Childcare vouchers to the same value.
- Result: Only £300 is subject to tax and National Insurance contributions. Childcare vouchers are exempt from both tax and Class 1 National Insurance contributions up to a limit of £55 per week.
When is it not possible to use salary sacrifice?
There are some situations where salary sacrifice cannot be used. Some examples of this are:
- Minimum wage: Employers cannot use salary sacrifice to reduce an employee's pay below the national minimum wage.
- Statutory pay: Salary sacrifice cannot be used to reduce an employee's entitlement to statutory pay. This includes sick pay, statutory maternity pay, or paternity pay.
- Pension auto enrolment: Employers must provide a minimum level of pension contributions for eligible employees under pension auto enrolment rules. Salary sacrifice cannot be used to reduce an employer's obligation to make these contributions.
- Redundancy pay: Salary sacrifice cannot be used to reduce an employee's redundancy pay entitlement.
- Tax and National Insurance limits: Salary sacrifice cannot be used to reduce an employee's pay below certain tax thresholds. This includes minimum amounts for income tax and National Insurance contributions.
What are the downsides?
Salary sacrifice can be a fantastic way to effectively increase employee earnings and save on tax. However, it can have an impact on anything that is linked to an employee’s salary. Here are a few things that can affect a decision to use a salary sacrifice scheme.
- Reduction in other benefits: Salary sacrifice may affect an employee's entitlement to other benefits that are calculated based on their salary. This can include overtime pay, bonuses, or redundancy pay.
- Impact on credit: Salary sacrifice can make it more difficult to prove income for employees seeking a loan or mortgage. This is because their gross salary will be lower than their actual earnings. However it's possible to provide a lender with a letter explaining that an employee is part of a salary sacrifice arrangement.
- Reduced flexibility: Salary sacrifice agreements can be binding for a set period of time. This can limit an employee's flexibility to change their arrangements if their circumstances change.
- Tax implications: Salary sacrifice could affect an employees' entitlement to other tax credits or benefits. These include Working Tax Credit and Child Benefit.
What else should you watch out for?
An employee's contract must be altered whenever they change whether they're opted in or out of a salary sacrifice arrangement. Their contract must be clear on what an employee's cash and non-cash entitlements are at any given time.
Tax and National Insurance advantages may not apply if an employee swaps between cash earnings and a non-cash benefit frequently.
Save money with salary sacrifice
Use our salary sacrifice calculator to find our how much your business and employees could save by switching to a tax efficient pension scheme.
Penfold's tech-first workplace pension makes it easy for employers to set up or convert to a salary sacrifice pension.
Speak to a Penfold salary sacrifice expert. A member of our team will explain how to save money with tax efficient pension contributions at your business.