Are you looking for ways to make your salary go further? Salary sacrifice arrangements could be the answer. But how does salary sacrifice work exactly?
This government-backed scheme allows you to agree with your employer to reduce your salary in exchange for valuable benefits like pensions or a car. The key benefit? It can lower your tax bill and boost your take-home pay.
Read on to dive deeper into how salary sacrifice works and if it’s right for you.
What is salary sacrifice?
Salary sacrifice is an arrangement where you and your employer agree to adjust your compensation structure. Instead of receiving your full salary in cash, you agree to give up a portion of your earnings each month in return for a valuable non-cash benefit offered by your employer.
The key advantage lies in how the scheme reduces your taxable income. Since you’re sacrificing a portion of your salary before taxes are calculated, your overall taxable income is lower. This translates to paying less income tax and National Insurance contributions. In simpler terms, by sacrificing a bit of your pre-tax salary for a non-cash benefit, you end up with a larger portion of your take-home pay.
Common examples of salary sacrifice benefits include:
- Pension contributions: This is one of the most popular forms of salary sacrifice. By opting to have a portion of your salary paid into your pension before tax is deducted, you can increase your pension pot and benefit from tax savings.
- Car or EV: Employees can lease a car or EV through salary sacrifice. This often comes with additional benefits like insurance and maintenance included.
- Cycle-to-work schemes: Employees can purchase a bike and cycling equipment through their employer and pay for it through salary sacrifice, often at a reduced cost.
- Gym memberships: Some companies offer gym memberships as a salary sacrifice benefit, allowing employees to enjoy discounted gym access.
- Technology equipment: Laptops, smartphones, or tablets can sometimes be provided through salary sacrifice, with employees making monthly payments through their salary.
How does salary sacrifice work?
In short, this is how salary sacrifice works:
- You agree: You and your employer agree on the amount you’ll sacrifice from your salary.
- Salary reduction: Your gross salary is reduced by the agreed amount.
- Benefit provided: Your employer provides the agreed-upon benefit, such as a company car or pension contributions.
- Tax savings: Because your salary is lower, you pay less income tax and National Insurance. Your employer also pays less National Insurance.
Benefits of salary sacrifice
Salary sacrifice can offer several financial advantages:
- Lower your tax bill: By reducing your taxable income, you can potentially save money on income tax.
- Pay less National Insurance: Salary sacrifice can lower your National Insurance contributions, increasing your take-home pay.
- Access valuable benefits: Enjoy perks like company cars or gym memberships potentially at a reduced cost.
- Boost your pension savings: If you choose to sacrifice salary for pension contributions, you can increase your pension pot while paying less tax on those contributions.
Downsides and considerations of salary sacrifice
While salary sacrifice can be a fantastic way to effectively increase employee earnings and save on tax, it’s essential to weigh up the potential drawbacks.
- Reduced benefits: Salary sacrifice can impact entitlements to benefits calculated based on salary, such as overtime, bonuses, or maternity/paternity pay.
- Borrowing implications: Proving income for loans or mortgages might be more difficult as your gross salary is lower, potentially limiting, for example, how big a mortgage you can get. However, a letter explaining your salary sacrifice arrangement might help.
- Limited flexibility: Salary sacrifice agreements often have a fixed term, restricting your ability to change arrangements if circumstances change.
- Tax credit impact: Your eligibility for certain tax credits or benefits, like Working Tax Credit or Child Benefit, could be affected.
- National minimum wage considerations: It’s crucial to ensure that your salary after sacrifice remains above the National Minimum Wage.
- Loss of income protection: Some income protection policies are based on salary, so sacrificing part of it could reduce your cover.
Examples of salary sacrifice
Example 1: Pension contibutions
- Salary: £4,000 per month.
- Salary sacrificed: £200 per month.
- Non-cash benefit received: £200 employer contribution to pension scheme.
- Result: Employee take-home pay increased by £24 per month due to reduced NI contribution. Employer NI contribution reduced by £26.50 per month per employee.
Example 2: Car lease
- Salary: £3,000 per month.
- Salary sacrificed: £300 per month.
- Non-cash benefit received: Company car lease.
- Result: Employee take-home pay reduced by £300 per month. However, the employee avoids the cost of car ownership (insurance, maintenance, etc.). The employee take-home pay may increase due to lower tax and NI contributions, but this depends on individual circumstances.
Salary sacrifice vs. Benefit in kind
Salary sacrifice involves exchanging a portion of your pre-tax salary for a specific benefit. A benefit in kind (BIK) is any non-cash perk provided by an employer. Unlike salary sacrifice, where your gross pay is reduced, a BIK doesn’t increase your gross pay. However, it is considered part of your income for tax purposes, meaning you’ll pay tax on its value.
Crucially, not all benefits are part of a salary sacrifice arrangement. In essence, all salary sacrifice arrangements involve a BIK, but not all BIKs are part of a salary sacrifice scheme.
Always check if a benefit is part of a salary sacrifice scheme before accepting it. This will help you understand the full financial and tax implications.
Is salary sacrifice a good idea?
Salary sacrifice can be a smart financial move, but it’s essential to fully understand the implications before deciding if it’s right for you. By agreeing to a lower salary in exchange for a specific benefit, such as a company car or increased pension contributions, you can potentially save on tax.
However, it’s important to consider the potential drawbacks. Salary sacrifice can affect your overall financial situation, including your eligibility for certain benefits and your ability to borrow money.
To make an informed decision, carefully weigh up the advantages and disadvantages based on your personal circumstances and financial goals. It can also be useful to use a salary sacrifice calculator to estimate your potential savings and to see how it could impact your take-home pay.
