The salary sacrifice scheme, also referred to as salary exchange, is a government-backed arrangement that allows employees to give up part of their salary in return for non-cash benefits.
Opting to receive a non-cash, pre-tax benefit, instead of your normal salary, has advantages for you and your employer. It reduces the amount of income tax and National Insurance you pay as an employee, and reduces your employer’s National Insurance contributions. This is because money is taken from your gross salary, rather than your net salary.
In this article, we’ll look at salary sacrifice in more detail, and explain why it can be a smart option, especially if you’re already paying a lot for certain products or services from your normal salary.
How do salary sacrifice schemes work?
Salary sacrifice is a voluntary, opt-in mechanism that allows employers to offer their employees non-cash benefits in exchange for a deduction from their normal salary. Employers usually choose a specific benefit partner when offering salary sacrifice to their employees, e.g. a healthcare or company car provider.
Unfortunately, even though salary sacrifice is popular among employees, many smaller businesses still don’t offer it as an option. According to a survey conducted by the Chartered Institute of Personnel and Development (CIPD), 41% of SMEs offer pension salary sacrifice, compared to 85% of very large organisations.
This is often due to the perceived complexity of setting up salary sacrifice and calculating the subsequent changes to tax and NI. However, the salary sacrifice process is actually very straightforward:
- The employer and employee agree on a specific benefit (and benefit provider) as requested by the employee, and calculate a corresponding reduction in the employee’s salary.
- Each month, the employee will receive their normal pre-tax salary minus the reduction that was agreed upon. As the deduction is applied before tax and national insurance are calculated, the employee pays less for the benefit that they would if they had to pay for it out of pocket.
Each time an employee chooses to sacrifice part of their salary for a non-cash benefit using salary sacrifice, or they change the specifics of an existing salary sacrifice agreement, it has to be added to their employment contract.
Salary sacrifice benefits
As we’ve already mentioned, salary sacrifice allows employees and employers to save money on income tax and National Insurance by taking money from their pre-tax salary. Depending on the amount of money they choose to sacrifice, and what they sacrifice it for, employees can save many thousands of pounds per year.
Additionally, many salary sacrifice schemes offer employees benefits that they wouldn’t be able to access otherwise. For example, cycle to work schemes effectively allow employees to buy a brand new bike, plus accessories, at less than retail price, in monthly installments. You would pay significantly more if you wanted to buy the same bike using your salary.
As not all employers offer salary sacrifice, companies often use salary sacrifice as a selling point to attract more talent. Then there are the health and lifestyle benefits that cycle to work schemes, gym membership and other fitness related initiatives provide.
Salary sacrifice disadvantages
While salary sacrifice has many positives, there are a couple of potential downsides that can catch people by surprise.
Firstly, because salary sacrifice reduces take-home pay, some people may find themselves struggling to cover their basic costs if they opt to sacrifice too much of their wage. This can be avoided with sensible discussion about any salary sacrifice arrangement between employer and employee.
Secondly, your take home wage determines your eligibility for many other social schemes and benefits. For example, your state pension is determined by the amount of National Insurance you pay. The more money you give up pre-tax, the less NI you’ll pay. This would, in theory, reduce your entitlement to state pension, although you would have to be paid less than £175 per week to miss the secondary NI threshold for 2023/24.
Common salary sacrifice examples
There are lots of potential avenues for salary reductions via salary sacrifice, some of the most common being:
- Pension contributions
Normal pension contributions total 8% of an employee’s salary — 5% paid by the employee and 3% matched by the employer. The employee and employer pay NI and PAYE contributions on this amount. However, with salary sacrifice, the money is committed to the pension before tax, meaning both the employee and employer save money on NI.
- Cycle to work schemes
Salary sacrifice can also be used for government-backed cycle to work schemes which allow employees to save significant sums of money on bikes and bike equipment. Cycle to work schemes in particular have many benefits. They save businesses and their employees money, help employees get fitter, reduce pressure on public transport systems, and are more environmentally friendly.
- Phones, laptops & other tech
Personal tech can be expensive, especially if you’re an employee on a modest wage. Luckily salary sacrifice can also be used to put money towards essential items like laptops or smartphones. In fact, certain providers allow businesses and their employees to sacrifice salary for all sorts of tech, even ‘non-essentials’ like a TV or games console.
- Gym membership
Many employers also allow their employees to sacrifice the cost of gym membership (which often includes family membership and extras). Employees save NI on the cost of the membership and, like cycle to work schemes, employers get an easy, effective way to encourage their employees to stay fit and healthy.
Each parent used to be able to sacrifice up to £55 per week towards childcare vouchers that they could use with approved childcare providers. Unfortunately, the scheme stopped taking new applicants in October 2018. However, the good news for parents is that they can now apply for the government’s new Tax-Free Childcare scheme which offers parents up to £2,000 per year for each of their children to cover childcare costs.
Salary sacrifice car scheme
One of the most popular salary sacrifice schemes for employees is for cars. Buying and owning a vehicle is can be significant drain on your finances, so many employees see salary sacrifice as the perfect opportunity to reduce their car ownership costs. However, salary sacrifice for vehicles works differently to most other forms of salary sacrifice. Firstly, salary sacrifice is usually applied to cars for personal use, rather then business use.
Salary sacrifice limits
Considering the variety of benefits you can choose for salary sacrifice, you’d probably expect there to be limitations to restrict how much you can sacrifice in total. However, that’s actually not the case. Theoretically you can sacrifice as much of your salary as you want, the only restriction is that you have to be paid above minimum wage after deductions have been made.
On the other hand, pension contributions are limited to £40,000 per year, so you’ll need to calculate your total contributions including the money your employer provides to ensure you don’t go over this limit.
Managing spend with Moss
Modern businesses face a huge variety of expenses and costs every day, from employee travel expenses to digital marketing. But without a centralised record of outgoing cash flow it’s easy to lose track of where your money is going.
At Moss we help businesses manage their money more effectively with a range of smart spend management tools. Our smart corporate credit cards and spend management software helps you understand exactly where your business’s money is being spent, on what, and by whom.
You can issue an unlimited number of virtual corporate cards for individual employees or departments and track, in real time, exactly what is being spent on each. Moss cards can be monitored directly from the Moss app, allowing you to approve spend or alter budgets whenever you need.
Salary sacrifice is an arrangement that allows employees to give up part of their pre-tax salary in return for non-cash benefits. This could be anything from a company car to additional pension payments. Salary sacrifice is backed by the government, and helps employees (and their employers) to save money by reducing tax and National Insurance payments.
Salary sacrifice should be arranged with your employer. Once you have agreed on the benefit and the corresponding value of the salary you will give up in return, the details of the agreement should be written into your contract.
Beside reducing companies’ National Insurance contributions, salary sacrifice has a number of additional benefits. It’s a great way to attract employees as not every company offers salary sacrifice, and it can help boost employee satisfaction and fitness, etc.