What Is Salary Sacrifice? Are You Missing Out?

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Salary sacrifice might sound like something you’d want to avoid (that’s why it's often called ‘salary exchange’.) But in reality, it’s one of the simplest, most tax-efficient ways for employers and employees to save money – and grow pensions in the process.

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What is salary sacrifice?

Salary sacrifice is a tax-saving arrangement between an employer and employee. The employee agrees to give up (or ‘sacrifice’) a portion of their salary, and in return, the employer provides a non-cash benefit – like a pension contribution.

Because the employee’s gross salary is lower, both parties pay lower National Insurance contributions (NICs). That’s right: everyone wins.

It’s all above board – salary sacrifice is backed by the government and can be easily set up by changing the terms of an employee’s contract once both parties are agreed. The key rule? The arrangement must not take the employee’s pay below minimum wage.

What are the benefits?

For employees:

• Lower National Insurance contributions: Salary sacrifice can result in lower National Insurance contributions for employees, helping them keep more of their earnings.
• 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 PAYE 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.

For employers:

• Reduced employer National Insurance: Employers lower their tax bill by saving money on employer NICs. Tax does not need to be paid on the salary that is sacrificed.
• Increased employee satisfaction: Offering salary sacrifice arrangements can help increase employee satisfaction and retention. Employees usually view the benefit as a valuable perk.
• 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.

Only 41% of small and medium enterprises (SMEs) 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 can salary sacrifice be used for?

Here are a few common non-cash benefits that salary sacrifice can fund:

1. 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.
2. Childcare vouchers: These can be used to pay for registered childcare. Vouchers can be received tax-free up to a certain amount each year.
3. Cycle-to-work schemes: Employees can sacrifice part of their salary to buy a bike and cycling accessories.
4. 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.
5. 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.

Salary sacrifice pension schemes

One of the most common methods employers take advantage is by making salary sacrifice contributions into employees’ auto enrolment pensions.

Instead of taking pension contributions out of an employee’s pay after tax, salary sacrifice deducts them before tax and NI. This means employees pay less National Insurance and get more into their pension pot – without having to lift a finger.

Salary sacrifice pension example

Before salary sacrifice:

• Gross salary: £30,000
• Employer Pension Contribution: £900
• Employer NI Contribution: £2,884.20
• Total Cost to Employer: £33,784.20
• Employee NI Contribution: £1,394.40

After salary sacrifice:

• Gross salary: £28,500
• Employer Pension Contribution: £2,400
• Employer NI Contribution: £2,677.20
• Total Cost to Employer: £33,577.20 (£207 saving!)
• Employee NI Contribution: £1,274.40 (£120 saving!)

Other salary sacrifice examples

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.

Are there any rules?

There are some situations where salary sacrifice cannot be used, 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.

Are there downsides to salary sacrifice?

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.

Want to see how much you could save?

We offer free salary sacrifice consultations for businesses. No jargon. No pressure. Just clear advice and simple next steps.

Whether you’re already running a pension scheme or looking to switch, our tech-first workplace pension makes salary sacrifice easy to adopt and simple to manage.

Request more information now or learn more about our salary sacrifice pension.