Salary Sacrifice Explained
Salary sacrifice is an employee benefit that allows employees to save by paying for certain benefits from their pre-tax salary. Employees can save on various expenses, such as pensions, childcare vouchers, and even electric cars. For employers, it’s an excellent way to show employees they are valued, which in turn supports retention and recruitment, as more people are increasingly considering benefits packages when choosing where to work.
In this article, we will explore the various benefits employees can have in salary sacrifice, while also examining how salary sacrifice works and any potential pitfalls that both employers and employees may encounter.
What Is Salary Sacrifice?
When an employee joins a company, the employer typically provides a list of available benefits. Salary sacrifice allows employees to pay for certain benefits directly from their pre-tax salary, which means they save on both Income Tax and National Insurance contributions. For example, instead of receiving their full salary and then paying for a benefit like a pension contribution or childcare vouchers, the cost is deducted from their gross pay, reducing their overall taxable income.
For employees, this can result in significant savings while also giving them access to valuable benefits, such as pensions, electric cars, or additional leave. From an employer’s perspective, offering salary sacrifice schemes is an excellent way to enhance their benefits package, making employees feel valued and contributing to higher retention rates. Additionally, certain salary sacrifice benefits, like electric vehicles, can support the company’s environmental, social, and governance (ESG) goals, further aligning the business with sustainable practices.
Happy employees contribute to a thriving and healthy company!
What Are The Benefits Of Salary Sacrifice?
The main benefit of salary sacrifice is the ability to pay less tax. By sacrificing part of their salary, the employee reduces their taxable income, which means both the employee and employer pay lower National Insurance contributions, and the employee pays less income tax.
What’s In It For The Employees?
Access to non-cash benefits - salary sacrifice allows employees to receive non-cash benefits, some of which they may not have been able to afford otherwise, like an electric car scheme for example.
Lower NI and Income Tax contributions - this can save the employee a lot of money and help them get the most out of their salary.
How Do Employees Benefit?
Increased employee satisfaction - as aforementioned, a salary sacrifice scheme can help with satisfaction and retention because this is a valuable perk.
Recruitment may become easier - Offering salary sacrifice can help attract and retain top talent and is often seen to be a competitive offering.
Reduced National Insurance - Employers pay less tax by saving money on National Insurance contributions. This is because tax doesn’t need to be paid on the salary that is sacrificed.
What Non-Cash Benefits Can Be Used?
There are several different options for non-cash benefits that employers can choose to offer their employees. Some examples of non-cash benefits that can be used with salary sacrifice include the following:
Regular Pension Contributions
This is one of the most popular salary sacrifice schemes in the UK. Employees can make pension contributions through salary sacrifice by reducing their salary in exchange for increased employer pension contributions. This allows employees to make extra contributions to their pension whilst also enjoying the tax benefits.
The minimum contribution to a workplace pension in the UK is 8% of an employee’s earnings with a minimum of 3% coming from the employer. The amount employees and employers contribute will vary depending on what pension scheme the employee has.
Up to £60,000 per year can be saved into a pension without it being taxed and this resets at the beginning of each tax year.
The table below shows how much an employee who earns £30,000 per annum could save by salary sacrificing their pension contributions. The pension contribution in this example is £125 per month. If the employee decides to salary sacrifice their pension, they could save £25 per month on Income Tax Savings and £15 on National Insurance, bringing the cost down from £125 to £85 per month!
| Category | Before Salary Sacrifice | After Salary Sacrifice |
|---|---|---|
| Gross Salary Per Annum | £30,000 | £30,000 |
| Monthly Gross Contribution | £125 | £125 |
| Income Tax Savings | £0 | -£25 |
| National Insurance Savings | £0 | -£15 |
| Net Cost Employee Pays Monthly | £125 | £85 |
Car Scheme
Employees can also salary sacrifice the cost of a car through providers like The Electric Car Scheme. This is a valuable benefit, especially for electric vehicles (EVs), where the upfront cost can be high and may otherwise feel out of reach.
The employer offers this as part of their employee benefits package, and the employee can then select the car they want, along with the lease period and expected annual mileage. Employees benefit from National Insurance and Income Tax savings, which are applied monthly.
The same benefits apply to a salary sacrifice car scheme. For example, if an employee earning £70,000 opts to salary sacrifice a Tesla Model Y through The Electric Car Scheme, with a 10,000 miles per annum limit and a three-year lease, they could see significant savings. By paying for the car through salary sacrifice, the employee could save £294 per month on Income Tax and £15 on National Insurance, reducing the monthly cost from £734 to £478.
With a car salary sacrifice scheme, employees will need to pay a small amount in company car tax otherwise known as Benefit-in-Kind tax (BiK).
| Category | Before Salary Sacrifice | After Salary Sacrifice |
|---|---|---|
| Gross Salary Per Anumm | £70,000 | £70,000 |
| Monthly Gross Contribution | £734 | £734 |
| Income Tax Savings | £0 | -£294 |
| National Insurance Savings | £0 | -£15 |
| Average Benefit-in-Kind Over Term | £0 | +£52 |
| Net Cost Employee Pays Monthly | £734 | £478 |
Childcare Vouchers
You can also salary sacrifice childcare vouchers, which works the same way as other salary sacrifice schemes, with National Insurance and Income Tax being deducted from the employee’s pre-tax salary. However, there are specific rules regarding the maximum amount that can be sacrificed each month and this depends on the employee’s tax rate.
Basic rate taxpayer: £243 per month
Higher rate taxpayer: £124 per month
Additional rate taxpayer: £110 per month
The vouchers can be used to pay for registered childcare like nurseries, after school clubs and nannies but childminding does not qualify.
Again, the table below shows how much an employee who earns £30,000 per annum could save by salary sacrificing their childcare vouchers. The childcare voucher will cost £243 per month due to the employee being a basic rate taxpayer. If the employee decides to salary sacrifice their childcare, they could save £49 per month on Income Tax Savings and £29 on National Insurance, bringing the cost down from £125 to £85 per month!
| Category | Before Salary Sacrifice | After Salary Sacrifice |
|---|---|---|
| Gross Salary Per Annum | £30,000 | £30,000 |
| Monthly Gross Contribution | £243 | £243 |
| Income Tax Savings | £0 | -£49 |
| National Insurance Savings | £0 | -£29 |
| Net Cost Employee Pays Monthly | £243 | £165 |
Cycle To Work Scheme
The cycle to work scheme allows employees to purchase bikes and accessories through their employer. Employees can hire the bike for the repayment period, which is usually a year, and then they can choose to buy it at the end for a fee. The cycle to work scheme was put into place to promote a sustainable commute which ultimately helps to build a healthier workplace.
The same applies for a cycle to work scheme. If the employee decides to salary sacrifice their bike, they could save £20 per month on Income Tax Savings and £12 on National Insurance, bringing the cost down from £100 to £68 per month!
| Category | Before Salary Sacrifice | After Salary Sacrifice |
|---|---|---|
| Gross Salary Per Annum | £30,000 | £30,000 |
| Monthly Gross Contribution | £100 | £100 |
| Income Tax Savings | £0 | -£20 |
| National Insurance Savings | £0 | -£12 |
| Net Cost Employee Pays Monthly | £100 | £69 |
Technology And Equipment
Employees can also salary sacrifice tech items by sacrificing their salary over a period of time. This can be beneficial for employees because it allows them to spread the cost of items and choose the tech that suits them best whilst saving.
If the employee decides to salary sacrifice their technology that costs £100 per month, they could save £16 on Income Tax savings and £10 on National Insurance savings. This would bring the cost down from £80 to £54 per month, which is a significant difference month-on-month.
| Category | Before Salary Sacrifice | After Salary Sacrifice |
|---|---|---|
| Gross Salary Per Annum | £30,000 | £30,000 |
| Monthly Gross Contribution | £80 | £80 |
| Income Tax Savings | £0 | -£16 |
| National Insurance Savings | £0 | -£10 |
| Net Cost Employee Pays Monthly | £80 | £54 |
How Does Salary Sacrifice Normally Work?
There are several steps needed to take salary sacrifice to work for both employees and employers.
Agreement Between Employer and Employee
The employer and employee must ensure the agreement works for both parties. This includes making sure the employee is happy with the benefit they’re receiving in return for a reduction of their salary.
Employee Eligibility
Both parties must ensure the employee is eligible for salary sacrifice. Each salary sacrifice scheme for different benefits will have its own eligibility criteria, but one of the most important factors is ensuring the employee’s earnings do not fall below the minimum wage at any point during the agreement.
Length Of Salary Sacrifice Agreement
Salary sacrifice agreements can last for an extended period, typically one to three years, depending on the non-cash benefit involved. Both the employer and employee must agree on the length of the contract, with the option to renew once the term is completed.
Is Salary Sacrifice Right For Me?
A salary sacrifice scheme can be a great option if you’re looking to drive a new car, especially an electric vehicle while saving money through tax benefits. It’s particularly worth it for those who want to reduce their carbon footprint and align with sustainability goals, both personally and within their company.
Salary Sacrifice Is Right For Employees If:
They want to save money: By utilising salary sacrifice, employees can reduce their income tax and National Insurance contributions by paying for benefits through their pre-tax salary.
They value convenience: Many salary sacrifice schemes bundle multiple services or benefits into one payment, simplifying the process and making it easier to manage.
They have stable employment: Salary sacrifice agreements are long-term commitments (usually 2-3 years), making them best suited for individuals who feel secure in their jobs and earn above the National Minimum Wage.
They’re looking for additional savings: Certain benefits offered through salary sacrifice, particularly those with tax advantages, can result in even greater savings over time.
Limits To Consider: When Salary Sacrifice Isn’t An Option
As aforementioned, if an employee earns the National Minimum Wage or works for a company with high staff turnover, a salary sacrifice car lease may not be suitable for you. The monthly payments are a long-term commitment, and the employee’s salary cannot drop below the minimum wage at any point. While there are some cases where you might be able to participate if you have variable pay, it’s generally not feasible.
Additionally, a salary sacrifice scheme may reduce an employee's entitlement to certain tax credits or benefits, such as Child Benefit or Working Tax Credit. It also limits flexibility, as salary sacrifice agreements are binding for a set period. This can make it difficult to adjust any arrangements if the employee's circumstances change, such as getting a new job or moving somewhere where a car is no longer necessary.
What Are The Downsides Of Salary Sacrifice?
There are several drawbacks to consider with salary sacrifice, as it involves a financial commitment over an extended period. Here are a couple of things to consider beforehand:
Reduction in other benefits: Because an employee is utilising their company’s salary sacrifice scheme, they may not be entitled to other benefits that are calculated based on their salary.
Impact on the employee’s credit: It can be more difficult to prove income for employees who are seeking a loan or a mortgage. This is because their gross salary is lower than their actual earnings. It is important to note that employees can prove that their salary is lower due to the salary sacrifice scheme via a letter.
Tax implications: salary sacrifice has the potential to affect an employee’s entitlement to other tax credits and benefits, like the Working Tax Credit and Child Benefit.
Lack of flexibility: salary sacrifice agreements can be binding for a set time. This can limit the employee’s flexibility in case their situation changes.
You can learn more about electric car salary sacrifice by visiting The Electric Car Scheme website. Employees can save between 30-60% on any electric car of their choice, both new and used. In doing so, employers can ensure their employees feel valued whilst also hitting key sustainability targets.
