How you could benefit from ‘salary sacrifice’ arrangements with your employer

Salary sacrifice is a contractual agreement between an employer and employee where the employee gives up an amount of their salary in return for non-cash benefits. Different benefits are available and several offer significant savings on income tax and national insurance contributions.

Salary sacrifice is often used to bolster pension pots, as the amount ‘sacrificed’ to contribute to the pension is non-taxable. This means someone using a salary sacrifice arrangement on their pension could pay less tax overall.

Employers benefit from the tax relief too, because it enables both companies and employees to reduce their national insurance payments. But companies must ensure the sacrificed portion doesn’t bring employees’ salaries below the minimum wage, which, in April 2024, rises to £11.44 an hour for workers aged 21 and above (1).

Salary sacrifice schemes also provide options to lease electric vehicles as company cars, buy bicycles through cycle-to-work schemes, or use workplace nurseries, all in tax-efficient ways.

Not all benefits however are tax free. Private healthcare from employers as well as household items such as tablet computers and mobile phones are still classed as taxable. But savings could be secured if these are obtained via a salary sacrifice scheme, rather than bought online or in-store.

Overall, the different benefits can broadly be placed into four categories: financial, family-related, household items and health.

Financial

Perhaps the biggest advantage of salary sacrifice concerns pensions, though employees have to first opt into workplace pension schemes to make use of it.

To demonstrate the mechanics here, an illustrative example can be given of someone on a £40,000 salary who sacrifices 5 percent of their pay (amounting to £2,000) to contribute to a pension scheme, while their employer pays another 5 percent (£2,000) into it.

First, the employer takes £2,000 from the salary, reducing it to £38,000, and contributes this to the employee’s pension.

The amount sacrificed is paid out of gross salary and is not subject to income tax or employee’s national insurance contributions (NICs).

The employer has also saved £276 of NICs on the amount salary sacrificed. If they were to gift this NIC saving to the employee then the total annual pension payments would be £4,276.

Without the salary sacrifice, the employee makes pension contributions out of their net salary and this is topped up by the government at the basic rate of tax at 20 percent. Higher and additional rate taxpayers can claim additional tax relief through self-assessment. The advantage of contributing through salary sacrifice is the employee’s and employer’s NIC savings, both of which are lost when making contributions from net salary.

This example carries several assumptions, but it depicts how pensions can be built up faster, and how employees can retain more of what they earn for later in life. Moreover, you might benefit from greater pension contributions from your employer, if they decide to give you some or all the money they save on national insurance contributions.

According to research conducted several years ago, 85 percent of very large companies offered salary sacrifice arrangements. But this fell to 61 percent of large companies and 41 percent of small and medium-sized enterprises (2). So, you may find yourself working for a company that does not offer salary sacrifice as a pension option.

Despite the tax advantages of salary sacrifice, there can also be disadvantages. For example, salary sacrifice leads to a reduction in your official salary. And a lower salary could potentially reduce the amount of money you’re able to borrow for a mortgage.

If you’re unsure whether salary sacrifice might be right for you, then you may benefit from speaking with a financial adviser. At Schroders Personal Wealth, one of our key principles is to have regular reviews with an adviser. This can help ensure you are making the most effective use of available tax benefits.

Family

Workplace nurseries are another example of salary sacrifice benefits. This option can be an attractive one for families juggling careers and living expenses.

Childcare vouchers were previously used as a tax-efficient benefit but these were closed to new applicants in October 2018, as the government rolled out the Tax-Free Childcare scheme. The voucher scheme involved exchanging a part of a worker’s salary for vouchers of the same value and using them with registered childcare providers.

Employees who were already using the vouchers before they were scrapped can still access them, but only on certain conditions. The main condition is that individuals must have already applied for the vouchers and received their first one by their last payday before 4 October 2018.

Household items and cars

While tax efficiencies don’t apply to the purchase of high-value tech items through salary sacrifice, savings can still be sought for laptops, phones and gadgets, when compared to high street prices.

More significant savings can be obtained through the leasing of electric vehicles as company cars, referred to as a taxable benefit in kind, which the government is keen to incentivise. The key point here is the tax rate for electric vehicles is currently just 2 percent of a set of factors including the list price. This is far less than the income tax rates of 20 percent or 40 percent if cash from normal income was used instead.

Health and fitness

Cycle-to-work schemes have become increasingly used by workers in big cities across the UK, with many keen to save on public transport or driving costs, while keeping fit and saving on tax liabilities.

It involves the employer purchasing the bike and leasing it to the employee. Sometimes employers can reclaim the VAT and pass this saving on to employees. When the leasing period ends, employees have the option to buy the bike from their employer.

Though they are taxable benefits in kind, gym membership, private health insurance and private GP access have become standard offerings now in salary sacrifice schemes. But the offerings vary by firm substantially.

General examples of savings can be viewed on salary sacrifice calculators online. Even so, reduced salaries that can result from salary sacrifice arrangements can negatively impact applications for credit cards and mortgages, as well as statutory maternity pay.

Sources:

(1) Gov.uk, ‘Minimum wage rates for 2024’, 21 November 2023.

(2 FT Adviser (www.ftadviser.com), ‘Less than half of SMEs offer salary sacrifice’, 13 December 2018.