Seeking a way to reduce your tax implications? An employee’s salary sacrifice scheme can be what you are looking for. It refers to the arrangement between an employer and employee where the employee agrees to give up part of their salary in exchange for a non-cash benefit. This can be pension contributions, cycle-to-work schemes, or childcare vouchers.
In this article, we will delve into how the salary sacrifice scheme works, its benefits, its possible disadvantages, and its best examples.
What is a Salary Sacrifice Scheme?
A salary sacrifice scheme is a simple way to make your money work harder without you having to do much at all. Accordingly, you set an agreement with your employer for a specific period of time. You agree to give up a bit of your salary, and in return, you gain a benefit and tax savings.
For instance, you can sacrifice a specific amount of money from your salary to get a new bike or even a car. At the same time, you can reduce your taxable income as the money you will sacrifice will be taken out before taxes are calculated.
Salary Sacrifice Benefits Examples
Examples of salary sacrifice benefits include:
- Childcare vouchers (closed to new joiners after 2018)
- Cycle to work scheme
- Electric car lease scheme
- On-site nurseries
- Workplace car parking
- Gym membership*
- Home computers*
- Prepaid store cards*
- Personal learning or training*
- Home electronics or white goods*
- Additional pension contributions
- Buying extra annual leave
- Mobile phones*
- Health screening or medical checkups*
* They may not offer the same level of tax and national insurance savings.
Is Salary Sacrifice Worth It?
Salary Sacrifice is a common thing that many people follow up on. But is it worth it?
Benefits of Salary Sacrifice
For employees:
- By reducing your net salary, you can take advantage of salary sacrifice tax benefits. This will help you reduce your employment income tax.
- You can also lower national insurance contributions. This is especially useful when contributing to a pension, as it allows for higher contributions at a lower personal cost. Thus, employees benefit from growing their retirement savings more efficiently.
- You can access non-cash benefits that you might not otherwise afford, such as electric vehicles, bicycles through the cycle-to-work scheme, or additional annual leave.
- It can also encourage more eco-friendly choices, such as using greener transport, aligning personal values with lifestyle.
For employers:
- By reducing the gross salary paid, employers also lower their national insurance contributions.
- Offering salary sacrifice can be a simple and cost-effective way to improve employees’ financial well-being and increase employee satisfaction.
Disadvantages of Salary Sacrifice
Salary sacrifice comes with a price. Initially, it reduces your gross salary and lowers your take-home pay depending on the benefit you choose.
While you reduce your tax liability and save on national insurance contributions, your lower salary can show itself when you try to take mortgage, loan, or even a credit card. The reason behind this is that lenders can only see your income, not the amount of salary sacrifice. Plus, it can cause you to have less life insurance coverage if it is based on your salary.
By making a salary sacrifice agreement, you can also reduce your eligibility for the state benefits such as statutory maternity pay, paternity pay, sick pay, or redundancy pay. These benefits are usually calculated based on your gross salary. Therefore, if you have reduced it through salary sacrifice, you will get fewer payments.
Apart from these, salary sacrifice pension contributions can be locked until you are 55, which is going to be 58 after 2028.
How Do Salary Sacrifice Arrangements Work?
The salary sacrifice scheme starts by making an agreement with your employer. In this salary sacrifice agreement, you receive non-cash benefits. Here, what you need to know is that this salary sacrifice scheme happens before tax and national insurance are calculated.
As an example, let’s say your salary is £30,000, and you agree to sacrifice £2,000 a year for additional pension contributions. Your taxable income becomes £28,000. Thus, you will reduce your taxable income in a given tax year and benefit from national insurance advantages.
These salary sacrifice arrangements are usually set up and managed through your company’s payroll system, so the deductions from your salary will happen automatically.
Note: Not all employers offer every type of salary sacrifice benefit, so you will need to check what’s available in your workplace. Plus, some schemes might come with minimum employee contract terms or conditions.
Examples of Salary Sacrifice Schemes
Now that we have covered the basic terms and conditions for salary sacrifice, it is time to make it clear through examples.
Pension Salary Sacrifice
If you want to boost your retirement savings, you can apply for pension salary sacrifice arrangements. By agreeing to give up a portion of your pre-tax salary, your employer will pay directly into your pension savings.
For example, if you earn £30,000 and sacrifice £2,000 into your pension, your new gross salary becomes £28,000. You avoid paying tax and NI on that £2,000. So, it reduces your take-home pay by around £1,360, considering that you are a basic-rate taxpayer. At the same time, £2,000 goes into your pension pot.
Childcare Vouchers
As a salary sacrifice scheme, childcare vouchers happen when you give up your salary in exchange for a non-cash entitlement: Childcare. For example, if you sacrificed £100 a month from your gross salary for childcare vouchers, you effectively save some money on your overall childcare bill.
Although the scheme closed to new joiners in 2018, it is a classic example of how salary sacrifice can help employees get valuable perks while saving on taxes and national insurance.
Cycle-to-Work Pension Schemes
Cycle-to-work schemes let you get a bike and equipment through your employer using salary sacrifice. Instead of buying the bike outright, you agree to give up part of your salary, gain tax advantages, and your employer buys the bike for you.
Let’s say you want a bike that costs £1,000. Through a cycle-to-work pension scheme, you agree to sacrifice £1,000 of your gross salary over 12 months. At the end of this period, you can often buy the bike at a fair market value, usually much cheaper than buying new.
EV Salary Sacrifice Scheme
EV salary sacrifice schemes allow you to lease a brand-new electric car through your employer by giving up part of your salary. This will allow you to make both an eco-friendly decision and save money by paying less income tax.
Is Salary Sacrifice a Good Idea for Me?
Deciding if salary exchange is a good idea for you can be up to your interests. To start with, you must ask yourself how much will be left for you. Plus, you must consider whether your whole money will be saved in national insurance contributions.
Considering your answers to these questions, if you want to save on tax and national insurance while getting non-cash benefits, salary sacrifice contributions can be good for you.
However, you must keep in mind that it might affect things like mortgage applications, as it can make it difficult to prove income. Therefore, you should check if it suits your personal situation.
Frequently Asked Questions on Salary Sacrifice Scheme
What is the maximum salary sacrifice?
There is no official maximum limit on salary sacrifice in the UK, but your reduced salary cannot go below the national minimum wage.
Does salary sacrifice affect pension?
Yes, but usually in a good way. If the sacrifice is made into your pension, it can boost your pension pot and reduce tax and NI.
Does salary sacrifice reduce taxable income?
Yes. The sacrificed amount is taken from your gross salary before tax and national insurance. Thus, it can reduce how much income tax and NI you pay.
How does car salary sacrifice work?
You give up a portion of your salary in exchange for a leased car. The payment comes from your salary.
Does salary sacrifice affect a mortgage?
It can. Since it reduces your official income, lenders might view your income as lower, which could reduce how much you can borrow.
What are the disadvantages of a salary sacrifice car scheme?
It reduces your gross salary, which can affect things like pensions, benefits, and mortgage applications.
Can I pay 100% of my salary into my pension?
You are allowed to put up to 100% of your salary into your pension, as long as it stays within the yearly limit (which is £60,000 for most people).
