What is Salary Sacrifice? Understanding the Basics and Benefits

Salary sacrifice is a financial arrangement in the UK that allows employees to give up part of their pre-tax salary in exchange for non-cash benefits.

This kind of scheme is popular and has several advantages, both for employers and employees and is a great way to save on taxes. 

Beyond tax savings, it’s also an excellent way to boost your benefits package and better support your team. Whether you’re a business owner or a People leader, this guide covers all you need to know about what salary sacrifice is, how it works, as well as the advantages and disadvantages of these types of schemes. It’s all detailed here!

What is Salary Sacrifice?

At its core, salary sacrifice involves an agreement between an employer and an employee. The employee agrees to give up some of their gross pay so it can be put towards something that will benefit them - whether that’s a bike for commuting, a pension pot they can save into or their dream company car. 

Now, of course, the employee could just buy that benefit directly. But here’s the advantage of doing so through a salary sacrifice scheme: anything bought through it isn’t taxable. It also lowers National Insurance Contributions (NICs). And your employees don’t have to claim tax relief on anything. This is what makes salary sacrifice so popular. 

A salary sacrifice pension is one of the more common examples of this type of scheme in the UK, but as you’ll see, there are lots of different benefits this can work with as well.

How Does Salary Sacrifice Work?

Salary sacrifice is actually pretty straightforward to set up: 

Decide what you want to offer

To start, you’ll want to decide what kind of scheme you want to offer as part of your benefits. Think about what makes the most sense based on who makes up the majority of your workforce. Is it young graduates living in the city? Or parents with childcare support needs? We’ll cover the most common types of non-cash benefits that make for good salary sacrifice schemes. 

Pick a partner

Then, you’ll need to find a partner who specialises in that particular scheme, like a pension provider, if you’ve not already got one set up. Remember that as per the Pension Act 2008, all eligible employees must be auto-enrolled into a workplace pension scheme, so you’ll definitely want to find and sign up for a pension provider if you haven’t already done so. 

Form an agreement

No salary sacrifice scheme can get off the ground without an agreement first in place. For each employee, you’ll need to agree with them on the amount of salary they’d like to shave off in return for the specific benefits. You should then lay this out in their employment contract. But remember, both of you will save money on the payments!

Employees receive their benefits

Once everything is in place, your employees can receive and enjoy their benefits. Remember, with things like pension contributions, your employees might want to come back and adjust these in future, so it’s never a ‘one and done’.  

What non-cash benefits are available through salary sacrifice?

From childcare vouchers to cycle-to-work schemes, there are lots of different salary sacrifice schemes available in the UK. The most popular are:

Salary sacrifice pension scheme

This is, of course, the benefit most frequently associated with salary sacrifice. By with salary sacrifice pension contributions, employees can lower their tax and NIC payments.  

Cycle-to work schemes

This is a particularly useful benefit for any city-based employees who needs to commute a distance to work. Employees can exchange part of their salary for bike and cycling accessories.

Childcare vouchers (or workplace nursery scheme)

One salary sacrifice option that’s lesser known, however incredibly useful, is for childcare support. To support with the soaring Cost of Living, you can offer working parents vouchers to spend with certain childcare providers or even access to a dedicated on-site nursery if they have one.  

Company car schemes

If your employees have a distance to drive to work every day or spend part of their workday driving to and from different clients, you can provide your workers with a company car through salary sacrifice. This will usually come in the form of a lease, but employees can also purchase a car via this route as well. 

Technology and equipment

A growing area for salary sacrifice is the offer of laptop, tablet and smartphone schemes. With the UK workforce becoming ever more digital, it can be incredibly handy to offer employees the opportunity to purchase technology and equipment tax-free at a reduced price.

What are some examples of salary sacrifice in the UK? 

To get an idea of what someone’s monthly take-home would be like with or without salary sacrifice, let’s look at a couple of different scenarios.

Salary sacrifice example 1: joining a workplace pension scheme 

Let’s consider what happens when an employee joins a workplace pension scheme on salary sacrifice. 

This table shows that an employee opting for a salary sacrifice into a pension plan not only boosts their pension pot but also slightly increases their take-home pay due to tax savings.

Salary sacrifice example 2: signing up for a workplace nursery scheme

In total, this person would save £5,040 a year or £420.00 a month if they opted for salary sacrifice. 

When isn't it possible to use salary sacrifice? 

Of course, while it’s possible to use salary sacrifice in a number of different scenarios, it’s not always appropriate, such as in the case of:

For instance, The UK has very strict laws around maintaining minimum and living wage rates, which means salary sacrifice cannot be used as a method to reduce an employee take-home pay below the National Minimum Wage rate. 

Similarly, salary sacrifice cannot be used to reduce an employee’s entitlement to statutory or redundancy pay or used to reduce an employee’s pay below certain income tax or National Insurance thresholds. It also can't be used as a method to reduce an employer’s obligation to make pension contributions. 

What are the advantages of salary sacrifice?

Tax efficiency is, of course, a big benefit for employees - through these schemes. They are able to lower their taxable income and less income tax and National Insurance. They also get access to enhanced benefits and products, which otherwise may have been unaffordable or unavailable otherwise.

As an employer, there are also benefits to be gleaned. For one, your company can reduce its NIC payments on salaries. Employee satisfaction also gets a boost because of the enhanced benefits packages your business is able to offer. That can result in better attraction and retention. 

What are the downsides to salary sacrifice? 

Still, not everything about salary sacrifice is so rosy. Here are a few things you’ll want to consider when offering employees these types of schemes. 

Reduction in Benefits: Salary sacrifice might reduce an employee's eligibility for benefits that depend on their salary, like overtime pay, bonuses, or redundancy pay.

Impact on Credit: Employees might find it harder to prove their income for loans or mortgages since their gross salary appears lower. However, they can provide a letter to the lender explaining their salary sacrifice arrangement.

Limited Flexibility: These agreements are often binding for a certain period, which may restrict an employee's ability to change their setup if their situation changes.

Tax Implications: Salary sacrifice can affect eligibility for tax credits or benefits, such as Working Tax Credit and Child Benefit.

To sump up 

Salary sacrifice is a valuable tool for both employees and employers, offering a way to make pay go further and benefits more comprehensive. While it comes with certain considerations and limitations, the financial and practical benefits can make it a worthwhile option for enhancing employee packages. If you're considering implementing or joining a salary sacrifice scheme, understanding the implications and benefits is crucial to making an informed decision.