While the idea of earning less money might seem strange at first, salary sacrifice can actually make sound financial sense. This is because the sacrificed portion of your salary may not be subject to Income Tax or National Insurance Contributions, depending on what benefit you choose.
What is Salary Sacrifice?
Salary sacrifice is a financial agreement between an employer and their employee. Under this agreement, the employee agrees to reduce their gross salary in exchange for a non-cash benefit of equivalent value. These benefits can take many forms, such as:
- Increased pension contributions
- Childcare vouchers
- Bicycles through the Cycle to Work scheme
- Additional annual leave
How Does Salary Sacrifice Work?
To enter into a salary sacrifice scheme, both employer and employee must sign a revised employment contract. This contract outlines the reduced salary and clearly states the non-cash benefit the employee will receive. You must put the agreement in place before the change takes effect and avoid applying it retrospectively.
As a basic example, you might decide to reduce your weekly pay by £50 in exchange for childcare vouchers of the same value. Because the benefit is exempt from Income Tax and National Insurance (if the scheme started before 5th October 2018), your overall take-home pay might decrease slightly, but your effective benefit is greater due to the tax savings.
Popular Salary Sacrifice Options
You can tailor salary sacrifice schemes to fit a variety of needs. Some of the most common types include:
- Pensions – You can boost your retirement savings by sacrificing part of your salary. This reduces your taxable income and helps grow your pension pot more efficiently.
- Childcare Vouchers – For those enrolled before October 2018, sacrificing salary for childcare vouchers remains a tax-efficient way to cover nursery costs.
- Cycle to Work Scheme – You can get a bicycle and accessories at a significant discount. You spread the cost over time and make the payments from your gross salary.
- Tech and Travel – Some employers offer mobile phones, laptops or travel cards. These benefits might be subject to tax, but bulk purchasing can reduce costs.
- Extra Holiday – You might also be able to buy extra days off. This intangible benefit can improve your work-life balance without affecting your post-tax income that much.
Who Can Use Salary Sacrifice?
Many employers use salary sacrifice schemes, but they do not have to offer them. Employers choose whether or not to offer them, and the range of available benefits may vary. Before participating, you should confirm with your HR department which schemes are on offer.
Employers must also ensure that the reduced salary does not bring your earnings below the National Minimum Wage. This is a legal requirement. If it does, the salary sacrifice arrangement cannot proceed.
What are the Tax Benefits?
One of the main advantages of salary sacrifice is the potential for tax savings. If the benefit is exempt from Income Tax and National Insurance, then both employee and employer save money.
For example: Benefits such as workplace pensions, employer-provided childcare (before October 2018) and bikes under the Cycle to Work scheme qualify for full tax exemptions. HMRC does not tax the value of the benefit or the portion of salary you give up to receive it.
HMRC treats other benefits, such as company cars or private health insurance, as Benefits-In-Kind. You will usually see this information on your P11D form. HMRC taxes them based on their value, and the employer reports them accordingly.
Lifestyle Changes and Opting Out
Life does not stand still, and sometimes your financial needs change. You might marry, start a family or experience redundancy in your household. Salary sacrifice schemes can account for these lifestyle changes.
You can opt in or out of a scheme at agreed points, and you must record each change by updating your employment contract. Frequent changes may lead HMRC to question whether your arrangement is valid for tax benefits.
Downsides of Salary Sacrifice
Although there are clear benefits, there are also potential drawbacks:
- Statutory Pay Risks – If your average earnings fall below certain thresholds, you may lose entitlement to statutory benefits such as Maternity Pay or Sick Pay.
- State Pension and Benefits – A lower salary means you pay less National Insurance. While that saves money now, it could reduce your eligibility for contribution-based benefits later.
- Loan Applications – Mortgage lenders and finance companies often assess affordability based on your gross salary. Lenders could offer you a lower loan amount if you have a reduced salary.
- Earnings-Based Pay – Your employer may calculate some bonuses, overtime, and pension contributions using your reduced salary. Always confirm how your company handles these calculations.
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