Salary sacrifice, also known as salary exchange, is an arrangement where an employee agrees to reduce their pre-tax annual salary in exchange for non-cash benefits such as goods or services. Common benefits include childcare, healthcare, transport, and enhanced pension contributions. Participation is voluntary, allowing employees to opt in and out as they wish. For example many schemes, like the Cycle to Work scheme, or flexible working (depending on the business) must be available to all employees.
Below are common examples of what salary sacrifice could include:
- Gym membership
- Health insurance
- Dental insurance
- Life insurance
- Home laptop or computer
- Personal learning
- Pre-paid vouchers for retailers
How Does Salary Sacrifice Work?
Before implementing a salary sacrifice agreement, both employer and employee should agree on the value of the benefits to ensure fair compensation, this could be claiming back an eye test or purchasing an E-Learning course online. Importantly, the arrangement cannot lower the employee’s earnings below the National Minimum Wage (NMW). Employers should have procedures in place to cap salary sacrifice deductions to maintain compliance with HMRC regulations.
For example, an employee with a £40,000 annual salary agrees to a new arrangement where they receive £35,000 in the bank and an additional £5,000 contribution to their workplace pension. Here, the employee sacrifices £5,000 of their salary to gain a £5,000 pension contribution.
Common costly salary sacrifices
Bike Scheme: Known as the Cycle to Work scheme, employees hire a bike for the agreement period, with the bike owned by the employer or a third party. Numerous providers in the UK facilitate this process. At the end of the hire period, employees can renew the agreement, purchase the bike, or return it.
Car Scheme: Similar to the bike scheme, employees can exchange a portion of their salary for a leased car. The monthly salary deduction covers costs like road tax, insurance, breakdown cover, servicing, and maintenance. The leasing company owns the car, which is returned at the end of the term.
Pension Contributions: Employers are required to contribute a minimum of 3% to the workplace pension scheme, though more can be added through a salary sacrifice arrangement. This increases the employer’s contributions, but these are essentially funded by the employee’s reduced salary. Contributions must not exceed the annual limit of £40,000, including employer contributions.
Childcare Vouchers: Although closed to new applicants who can now use Tax-Free Childcare, employees enrolled before October 4, 2019, can sacrifice up to £55 a week of their salary for vouchers of equivalent value for registered childcare providers.
Tax and National Insurance Contributions: Salary sacrifices reduce pre-tax salary, allowing employees to save on income tax and National Insurance contributions. For example, if an employee earns £350 per week and sacrifices £50 for childcare vouchers, only £300 is subject to tax and National Insurance. Employers also benefit by saving up to 13.8% on employer National Insurance contributions.
Non-cash benefits must be reported to HMRC at the end of the tax year using the online end-of-year expenses and benefits form.
Pros and Cons to the Salary Sacrifice scheme
Of course, everything has a pro and a con, but weighing up whether your business should run a salary sacrifice scheme is an important part of payroll management for budgeting. See below the advantages and disadvantages to this scheme below:
Advantages of the salary sacrifice scheme
- Employees save on income tax and National Insurance.
- High-cost items like cars or bikes become more affordable through monthly salary deductions for employees.
- These benefits can be used for both personal and business purposes, potentially reducing business mileage claims.
- Employers can attract and retain staff while saving on employer National Insurance contributions.
Disadvantages of the salary sacrifice scheme
- Reduced salary may affect credit or mortgage applications and work-related statutory payments like maternity or sick pay for employees.
- Employees using car leasing schemes might face Benefit in Kind (BIK) tax, especially if the car is not an ultra-low emission vehicle.
- High staff turnover can create complications, such as ongoing lease payments or early termination charges for car leases.
PayEscape can help
Salary sacrifice offers a flexible way for employees to receive non-cash benefits while saving on tax and National Insurance. However, it requires careful planning and consideration of its impact on statutory benefits and overall compensation. For more detailed guidance, employers should consult the government website or speak to a payroll and HR provider online. Get in touch with PayEscape today to find out more on how you can run your business smoother.
Can employees opt in and out?
Yes, salary sacrifices are voluntary. Contract alterations are required with each change. Arrangements typically last at least 12 months unless there’s a lifestyle change.
Does salary sacrifice appear on payslips?
Yes, the sacrificed amount is shown as a pre-tax deduction.
Can salary sacrifice be backdated?
No, it takes effect from the agreement date.
Is salary sacrifice mandatory?
No, it must be agreed upon by both employer and employee.
Where to find more details?
Visit the government website for comprehensive information or consult with payroll experts or accountants.
Will there be an Impact on payments and benefits?
- Earnings-Related Payments: These can be based on either the notional or the reduced salary, but this must be clearly communicated to employees.
- Earnings-Related Benefits: Salary sacrifice can affect entitlement to benefits like Maternity Allowance and Additional State Pension, potentially reducing or eliminating them.
- Contribution-Based Benefits: It may impact benefits like Incapacity Benefit and State Pension, as lower cash earnings result in lower National Insurance contributions.
- Statutory Payments: If the arrangement reduces average weekly earnings below the lower earnings limit, statutory payments may not be required.
