Salary sacrifice is the process whereby an employee gives up an amount of pre-tax salary in return for a benefit from their employer at a generally advantageous rate.
The form of benefit is largely non-cash, such as childcare vouchers or an increased pension contribution.
As a result of your lowered salary, the amount of tax and national insurance you are liable to pay is reduced. Your employer will also pay a lower amount of staff national insurance contributions (NICs).
Salary sacrifice is a voluntary arrangement with your employer. You cannot be forced to take part in a salary sacrifice scheme.
However, some employers automatically enrol their employees onto their scheme. In this scenario, if you do not wish to participate, you must inform your employer. If you do not, they are within their rights to presume that your silence signifies permission.
Salary sacrificing can be beneficial to you in a number of ways – the most obvious being the tax benefits it provides, but as with any financial decision, you should fully investigate the benefits and disadvantages before entering into this type of arrangement.
Before you consider salary sacrificing, you might find it helpful to read How to Calculate Your Take-Home Salary.
Where Does Salary Sacrificing Happen?
The most prevalent use of salary sacrificing happens in the UK, although employees across Europe, Australia and New Zealand may also be offered this opportunity.
In Australia, the term ‘salary packaging’ is generally used instead of salary sacrificing. At this time, there is no equivalent to salary sacrifice offered widely in the US.
The most common benefit offered across participating countries in connection to salary sacrificing is an increased pension contribution, although schemes in the UK generally offer the greatest variety in employee benefits.
In New Zealand, the general option for salary sacrifice is to pay that portion of the employee’s salary into their KiwiSaver scheme. KiwiSaver is a government initiative to assist citizens to save towards their first home or their retirement.
In Australia, benefits are generally commodity-related – for instance, cars or computer equipment, although some employers also offer childcare, parking and pension contributions.
Salary sacrifice schemes vary not only between countries, but also between companies. Check with your HR department to find out exactly what your employer offers.
What Can Salary Sacrifice Cover?
Additional pension contributions are the most popular benefit offered to employees in a salary sacrificing arrangement, but they are not the only option available.
You may find that your employer offers any of the following benefits.
Many employers encourage their workforce to participate in their ‘cycle to work’ initiative to offset the company’s carbon footprint and improve the overall health of the workforce.
Generally, you will lease the bicycle of your choice, possibly along with safety equipment, from your employer.
Once the lease period is over, you have the option to buy the bicycle at a fair price that reflects its age and depreciated value. In the UK, this price is set by the HMRC to guarantee fairness for employees.
Your employer may offer a salary sacrifice car scheme. Similar to the cycle to work scheme, you will lease the car through your employer and have the option to buy the car at a reasonable price once the lease period ends.
Servicing, maintenance costs, insurance and car tax will generally be included, but you are advised to check this with your employer.
Increasingly, employers prefer to offer ultra-low emission vehicles, such as electric cars and plug-in hybrids.
Where you have to pay regular car parking fees for work purposes, a salary sacrifice scheme may offer the option to obtain a reduced price annual parking permit.
Many employers offer a salary sacrifice childcare scheme. This may be in the form of childcare vouchers to spend at the nursery or childminder of your choice, or to cover the cost of on-site childcare provided by your employer, such as a nursery based on a university campus.
In the UK, where the salary sacrifice childcare scheme is provided tax-free by the employer, you are not allowed to also use the UK Government provided Tax-Free Childcare scheme.
Similar to the bicycle and car salary sacrificing schemes, computer equipment, such as desktop computers and tablets, can be leased through your employer. At the end of the lease period, you have the option to buy.
Maintenance may be included in the scheme, but it is always recommended that you check this detail with your employer.
Some employers will offer a gym membership in return for your salary sacrifice. This will generally be a reduced rate from the price you would pay yourself.
You may be able to buy a new mobile phone through a salary sacrifice scheme, paying off the total in instalments. The price may be a reduced rate, but the phone will be supplied without a contract or SIM.
This is the most widely recognised benefit of a salary sacrificing scheme.
The portion of your salary that you sacrifice is paid into your work pension. As a result of your reduced salary, you will pay less tax and national insurance, and your employer will also pay less NICs.
Certain employers may be willing to instead pay that portion of NIC into your pension.
Pros and Cons
Salary sacrifice schemes can be beneficial, but they also have their downsides. Here are the pros and cons of salary sacrificing:
Reduced Tax and National Insurance Liability
The most obvious advantage of salary sacrificing is that, with a lowered salary, your liability to pay tax and national insurance will also be lower.
However, this does not mean that the benefit you receive in exchange for the sacrificed salary is necessarily tax-free. That will depend on the type of benefit you receive.
For instance, in the UK in 2021, the following salary sacrifice benefits are tax-free:
- Employer-provided childcare
- Ultra-low emission vehicles
- Retraining courses
- Outplacement services
- Certain intangibles, such as extra annual leave
So it is important that you find out exactly how salary sacrificing will affect your tax and national insurance liability.
Many of the benefits, such as cars, bicycles, and computer equipment, received in exchange for a salary sacrifice will be at a lower price than if you had purchased them personally.
For instance, you might normally pay £120 for an annual parking permit, but through the salary sacrificing scheme at work, the permit costs you 10% less at £108.
The reason for this is that employers are able to buy many benefits, such as bicycles or computer equipment, in bulk and therefore at a lower price.
Makes Ownership a Possibility
In addition to the reduced price, the ability to pay for an item in instalments through a salary sacrifice arrangement with your employer may mean that ownership of a brand new electric car or the latest computer model becomes a possibility.
Leasing an item, such as a computer or a bicycle, through your employer salary sacrifice scheme opens up newer and more expensive models than you may have not been able to afford as an individual consumer.
Helps Save for Retirement
Using a salary sacrifice scheme to pay more into your work pension provides a double tax advantage.
First, it reduces the tax payable on your salary. Second, the amount you sacrifice and pay into your pension is tax-free. Your pension pot will benefit from the entire sacrificed amount.
Increased Tax Credits
The lower salary may make you eligible to claim increased tax credits, or even tax credits at all.
Lower Salary May Affect Entitlements
A lower salary, as a result of the sacrificed amount, may affect other entitlements that you receive currently or may wish to apply for in the future, for instance:
- The contribution your employer pays into your pension as a percentage of your salary
- The amount of money you can borrow in a mortgage
- The maternity or paternity pay you would receive
Before you agree to join a salary sacrifice scheme, you should check how your lower salary will affect any entitlements.
Not Suitable for Low Income Employees
Salary sacrificing is generally unsuitable for employees with a lower salary.
This is because reducing your salary may take it below the national minimum wage or national living wage, depending on your age.
How Does Salary Sacrificing Affect Your Contract of Employment?
Should you decide to enter a salary sacrificing agreement with your employer, it will affect your salary payment and working conditions.
Your contract of employment must, therefore, be altered to reflect these changes. This may be done through a newly drawn-up contract or by way of an addendum or attached letter.
Will a Bad Credit Rating Get In the Way?
No, your credit rating has no effect on whether your employer allows you to sacrifice a portion of your salary in return for a benefit.
You are in no way applying for credit or building a debt. However, if you have a considerable level of debt, it may be wise to avoid salary sacrificing.
Is There a Maximum Salary Sacrifice?
No, there is not a maximum amount of your salary that you can sacrifice, but your lower salary must not be below the national minimum or living wage.
Are Salary Sacrificing Schemes the Same as Flexible Benefit Packages?
A flexible benefit package offers employees the chance to buy certain benefits, such as extra annual leave or life insurance.
The main advantages of a flexible benefit package are the reduced cost of the benefit due to the fact that an employer can purchase these items in bulk – and therefore at a lower price – and that the employee can adapt their benefits package to suit their needs.
However, not all benefits available through flexible benefit packages are tax-free.
Salary sacrificing is one method that employers use to make flexible benefit packages available to their workforce.
What to Consider Before You Enter a Salary Sacrifice Scheme
When you are faced with the decision of whether to enter a salary sacrifice scheme, here are the factors you should first consider:
- Can you afford to live on a lower salary?
- Will the salary sacrifice push you below the national minimum or living wage?
- What effect will the lower salary have on your tax and national insurance liability?
- Will the reduced national insurance liability affect your state pension?
- What entitlements will the lower salary affect, both current and in the future?
- Will the lower salary make you eligible for other entitlements, such as tax credits?
- Is this benefit tax-free or not?
- Has your employer provided you with a calculation of your amended take home pay if you enter into the salary sacrifice scheme?
- Where the benefit is an item, such as a car or computer equipment, will you pay a lower price through salary sacrifice than you could accomplish as a personal shopper?
- Does your employer offer the model of car, etc, that you want to buy or is the choice limited?
- Are extras, such as car maintenance or bicycle safety equipment, included in the price?
- How much will the extra payment into your pension affect your retirement income?
- Where the benefit is additional payment into your pension, will your employer contribute the NIC that they no longer need to pay to the HMRC into your pension?
- Are the available benefits necessities or simply perks?
- What are the conditions if you cancel the arrangement or leave that company?
- Will salary sacrificing be to your overall advantage?
Salary sacrificing can be a useful way to reduce your tax liability, boost your pension pot, and help you to afford items that would otherwise have been out of your reach.
However, like any financial decision, it is important that you are fully aware of how the salary sacrifice will affect your finances, that you read the fine print of the agreement with your employer and you use the opportunity to buy something that you actually want or need.