This article explains what salary sacrifice is, what is covered under the salary sacrifice scheme and how it can save employers and employees money by reducing the amount of National Insurance you pay.
You can use our free online Salary Sacrifice Calculator here: Salary Sacrifice Calculator ( UK Only 2014 Tax Year+ )
What is Salary Sacrifice?
Salary sacrifice is a contractual arrangement* where an employee gives up the right to receive part of their cash remuneration (typically salary but this open to interpretation and could be applied to cash bonuses), usually in return for your employer's agreement to provide some form of non-cash benefit (including, but not limited to, child care vouchers, personal pension, bicycles and bus passes).
When an employer sets up salary sacrifice scheme, they will need to alter the employment contract or alter the employee's terms and conditions to reflect the salary sacrifice agreement. Salary sacrifice does not mean that your annual agreed (contracted) salary is changed, you will still earn the same amount but the salary sacrifice element will be deducted before national insurance and tax deductions.
If you are an employer considering setting up a salary sacrifice scheme, it is essential that you take legal advice to ensure that the employment contract is drawn up correctly to protect you and your employees.
* Contractual Arrangement An agreement with specific terms between two or more persons or entities (in salary sacrifice example, the contract is between you, your employer/employee and HMRC) in which there is a promise to do something in return for a valuable benefit known as consideration. In the case of salary sacrifice, the consideration is a the combination of pension tax allowances and a reduction in National Insurance due to the reduction in annual salary.
Salary Sacrifice is NOT
- Compulsory for all employers. Salary sacrifice is a voluntary scheme, its is completely at the discretion of the employer as to whether they implement a salary sacrifice scheme
- Compulsory for all employees in a company that has a salary sacrifice scheme. Employees can opt in or out of salary sacrifice schemes at their own discretion.
- A good solution for everyone, financial situations are different for everyone. Ensure you take independent financial advise when considering a salary sacrifice scheme
- A confirmed agreement for the rest of your career, companies can cancel salary sacrifice schemes should they wish to do so. In this instance your salary should return to its previous rate and your contract be amended. It is unusual for companies to u-turn on salary sacrifice schemes but NOT impossible.
Salary Sacrifice Responsibilities
- HMRC is responsible for identifying how national insurance and tax will be applied to the salary sacrifice scheme. Most salary sacrifice schemes have the same rules applied for tax and national insurance contributions but in some instances there may be tax exemption rules or national insurance exemption ruling applied. Pension salary sacrifice is one example of national insurance exemption but there are restrictions on the amount you and your employer can contribute. Pension salary sacrifice benefits employers and employees as both receive national insurance payment reductions, it is one of the better government initiatives in recent years. HMRC will not advise on the structure of the salary sacrifice as this is a contractual change between the employer and the employee, HMRC limits its obligations to reviewing the application on national insurance contributions/exemption and tax deduction/exemption as necessary
- Employer is responsible for liaising with HMRC and the employee(s), altering the employees' terms and conditions in relation to pay and the salary sacrifice scheme and operating and remaining within HMRC legislation.
- Employee is responsible for reviewing the salary sacrifice documentation provided by their employer and either opting into or out of the salary sacrifice scheme. It is unusual to opt out as typically you will benefit from a salary sacrifice scheme.
When does salary sacrifice become effective?
Salary sacrifice becomes effective when the following criteria have been met:
- Employer has set up a salary sacrifice scheme
- Employer has conformation from HMRC that the salary sacrifice scheme is acceptable (HMRC has to be satisfied that the salary sacrifice is effective)
- Confirmed that employee has given up the right to some of their cash pay in return for the benefit and that the scheme is not just a means if altering the employees pay rate
- Reviewed how national insurance and tax will be applied to the scheme
- Reviewed the employers contract to confirm that the pay element has been adjusted to reflect the salary sacrifice scheme
- Confirmed when the initiative will become effective and how the salary sacrifice is applied
- Confirmed the contractual right to cash pay has been reduced:
Employer has provided information to the employee on the salary sacrifice scheme Employee has confirmed they wish to participate in the salary sacrifice scheme First salary transaction including adjustment for the salary sacrifice
- The potential future remuneration must be given up before it is treated as received for tax or NICs purposes
- The true construction of the revised contractual arrangement between employer and employee must be that the employee is entitled to lower cash remuneration and a benefit
Employee considerations - Should you opt into a salary sacrifice scheme?
As with all finical decisions, the emphasis is on the individual opting into or out of the scheme to fully appraise themselves of the scheme and understand whether it makes financial sense to proceed with the salary sacrifice.
Reading this article on salary sacrifice does not make you an expert, it simply provides you an insight into the salary sacrifice scheme. It is imperative that if you take independent financial advise, particularly if are unsure of whether the scheme is of financial benefit to you.
As a simple starting point, when reviewing a salary sacrifice scheme you need to consider the following factors:
- Will this affect my future salary rises? Ensure that your terms and conditions calculate any future salary uplifts (annual pay rise / bonus / promotion) on the original baseline gross salary.
- Will this effect my company pension? Dependant on the sacrifice scheme and how your pension is calculated your total pension could reduce (except when the salary sacrifice scheme is specifically geared towards a company pension. In this instance the scheme is designed to increase company pension enrolment by reducing national insurance contributions for employers and employees.
- Will I (still) be entitled to Working Tax credits / Child Tax credits / Family allowance
- How will salary sacrifice effect my state pension?
Salary Sacrifice - The Pros
- Employee - You pay less National Insurance Contributions (NICs)
- Employer - You pay less employers National Insurance Contributions (NICs)
- Employee - You may end up with a higher pension compared to that if you opted out of the salary sacrifice scheme, dependant on how your employer structures the salary sacrifice scheme.
Salary Sacrifice - The Cons
- If you leave your employment within a specific period you may lose part of the payments (pension plan dependant, ALWAYS CHECK!!!)
- If your employer provides life cover, this may be calculated of your reduced salary, ALWAYS CHECK!!!
- Mortgage calculations - this is not typically an issue these days as most mortgage provides have salary sacrifice schemes and understand how they work. Some however may only provide mortgage calculations based of your Gross pay after salary sacrifice (simple answer, shop around for your mortgage or have your company draft a letter explaining the scheme)
- If salary sacrifice brings your salary below the Lower Earnings limit level, your entitlement to Statutory Maternity Pay and State Second Pension may be lost. You can find the latest Lower Earning Limits and Personal allowance for 2023/24 tax year here.
Salary Sacrifice Calculator
You can see how much you would earn before and after salary sacrifice using our Salary Calculator - Updated for 2023/24 tax year. Make a note of the difference in National Insurance Contributions and Tax payments, this is where you will see the difference from salary sacrifice
Salary Sacrifice Further Reading