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Salary sacrifice schemes offered by employers are becoming an increasingly popular way for employees to make tax savings. By agreeing to sacrifice part of your salary in return for non-cash benefits, you can reduce your taxable pay and therefore pay less income tax and National Insurance contributions (NICs). Here is an overview of how salary sacrifice schemes work and the key tax benefits they offer employees in the UK.
What is Salary Sacrifice?
A salary sacrifice arrangement, or salary exchange, is an agreement between an employer and employee where the employee gives up part of their salary in return for a non-cash benefit. Common salary sacrifice benefits include pension contributions, childcare vouchers, cycle-to-work schemes, cars, and technology devices.
The key difference compared to normal employee benefits is that the employee’s gross pay is reduced by the amount sacrificed. Their taxable pay is lower, so they pay less income tax and NICs. The employer can also save on employer NICs, calculated on an employee’s taxable pay.
How Do Salary Sacrifice Schemes Reduce Tax?
There are two main ways that salary sacrifice arrangements can reduce taxes for employees:
- Lower Taxable Pay: As the amount sacrificed is deducted from your gross salary before tax is calculated, it reduces your taxable income. This means you avoid paying income tax and NICs on the sacrificed amount.
- National Insurance Savings: Most salary sacrifice benefits are exempt from employer and employee NICs. This means you save the NICs you would have paid if receiving that part of your salary as normal cash pay.
In 2022/23, the main NICs rates are 13.25% for employers and 12% for employees. So salary sacrifice can produce significant NIC savings for both parties.
Tax Benefits of Common Salary Sacrifice Schemes
Here are some of the most popular salary sacrifice arrangements and how they can reduce your tax bill:
Pension Contributions: Making pension contributions via salary sacrifice rather than out of your take-home pay allows you to save income tax and NICs on the amount contributed. Higher-rate taxpayers can make the most tax savings.
Childcare Vouchers: These allow you to sacrifice up to £55 a week (£243 a month) tax-free if you joined a scheme before October 2018. You avoid tax and NICs on the vouchers.
Cycle to Work Scheme: You can get a tax-free bike and accessories up to the value set by your employer by sacrificing part of your salary. Saves you income tax and NICs.
Company Car: Taking a company car under a salary sacrifice arrangement means you only pay tax on the reduced salary figure, saving tax and Class 1 NICs.
Technology Devices: You can get tax relief by sacrificing part of your salary to lease technology products like phones and laptops.
Other Schemes: Further options like car parking, health screening, gym membership, and green travel schemes can also produce tax savings.
Sacrificing salary for benefits only makes sense if the tax you save is greater than any loss caused by the reduction in pensionable pay. It’s important to understand your specific savings before entering a scheme.
Who Can Benefit From Salary Sacrifice?
Salary sacrifice arrangements are available to all employees, but higher and additional rate taxpayers will benefit most. Workers earning less than the personal allowance (£12,570 in 2022/23) will not gain any income tax advantage. To sacrifice salary, you must have a contractual change to your terms and conditions. Salary sacrifice cannot apply retrospectively to your normal take-home pay. Both you and your employer must agree to the arrangement.
Salary sacrifice can reduce your entitlement to state benefits like statutory maternity/paternity pay. Careful planning is required to claim benefits like tax credits and Universal Credit. To sum it up, opting for a salary sacrifice scheme can be tax-efficient for employees to receive non-cash benefits. When structured correctly, it can lead to savings on income tax and National Insurance by reducing taxable income.