Salary sacrifice is a government-backed scheme to help employers and their workers save on tax by paying into a pension.
Here, an employee effectively ‘swaps’ part of their salary for another benefit, in this case, pension contributions.
The employee agrees to give up a small part of their earnings, reducing their overall salary. These ‘sacrificed’ earnings are then added directly into their workplace pension, ready for their retirement.
Today, only 41% of smaller enterprises offer Salary sacrifice, compared with 85% of large organisations. For many SMEs, salary sacrifice represents a simple way to trim their tax bill while helping their employees keep more of what they earn.
When an employee agrees to take part in a salary sacrifice scheme, they essentially agree to use a small part of their monthly pay for their pension.
Rather than paying a part of their earnings into their pension every month, they get paid less on the agreement that any money they sacrifice goes straight into their pension instead.
They are reducing their monthly take-home pay now in exchange for more money in their pension for the future.
The benefit of doing this is that by reducing the money they receive right now, they owe less tax and get to keep more of what they earn overall.
Here’s an example of Salary sacrifice in action. Rachel works for a small business and earns £50,000 a year.
Before Salary sacrifice:
After Salary sacrifice Rachel keeps more of her earnings:
As a result Rachel keeps hold of £331.25 extra every year!
Salary sacrifice is a great option for helping your employees keep more of what they earn. Here are the main 3 advantages of Salary sacrifice for your team.
Including extra employer contributions.
Increasing how much of their money employees get to keep.
Employees won’t have to claim it from HMRC themselves.
Because salary sacrifice reduces an employee's earnings, it also reduces the amount of National Insurance a company owes.
National Insurance tax is calculated on gross salary - before any deductions. Reducing an employee’s ‘on paper’ salary means you’ll owe less in employer National Insurance contributions.
Using Sarah’s example, rather than paying National Insurance on £50,000 a year, you’re now taxed on £47,000 a year. Remember, you’re still paying the same amount in pension contributions.
Here’s the main takeaway. You’ve just saved your business £327.75 a year simply by switching schemes. And that’s only for one employee. The bigger your team (and the more your employees earn), the more you save.
These savings are based on the recent National Insurance tax increases, introduced in April 2022. (Based on a £50,000 average salary).
£16,387.50 annual saving.
£32,775 annual saving.
£81,937.50 annual saving.
You may be familiar with the idea of employee pension contributions being paid pre-tax, before Income Tax and National Insurance deductions. This is known as the ‘Net Pay’ approach. salary sacrifice is a little different.
With ‘Net Pay’ your employees pension contributions still come from their salary. Their yearly earnings don’t change, they just use a percentage of their income to pay into their pension.
For salary sacrifice, technically the employee doesn’t pay anything into their pension. All contributions come from the employer, supported by the employee’s sacrificed earnings.
It’s a small difference that doesn’t affect how much goes into their pension - but has a big impact on how quickly tax relief is added to their pot. No more waiting for HMRC.
While salary sacrifice can be a fantastic way to effectively increase earnings, it will have an impact on anything that is linked to an employee’s salary. Here are a few things that may affect your decision to switch to a salary sacrifice scheme.
You won’t be able to use salary sacrifice where it would reduce an employee’s earnings under minimum wage.
Any salary-linked life insurance or loan applications may be affected. Typically this can be explained to the lender with a letter.
Typically statutory maternity pay is calculated based on average weekly earnings so could be reduced if your overall salary is reduced.