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What is a salary sacrifice scheme?

Salary sacrifice scheme work as a kind of employee benefit by allowing employees to receive non-cash benefits in exchange for giving up a part of their salary.

Salary sacrifice is defined by HM Revenue and Customs (HMRC) as an “agreement to reduce an employee’s entitlement to cash pay, usually in return for a non-cash benefit.”

How does it work?

Salary sacrifice is an agreement between the employer and the employee in which the employee agrees to sacrifice a part of their salary in return for certain benefits of equal value. It means that the employer pays certain agreed-upon benefits directly and the cost is deducted from the employee’s salary. An employee may also sacrifice a bonus or other such one-off item. The deductions in the salary are made before calculating the national insurance contributions and income tax.

If you want to know how national insurance is calculated, please refer to our guide here

What is the purpose of a salary sacrifice scheme?

Salary Sacrifice schemes entail savings for both the employer and the employee in the form of,

  • Tax reduction
  • Less National Insurance contributions (NI)

When employees receive certain benefits from the employer in exchange for salary reduction then tax is applied only to the salary and not to the benefit.

Example of a salary sacrifice scheme

An employee with a weekly salary of £350 has agreed to a salary reduction of £50 in exchange for the non-cash benefit of a childcare voucher. The value of this voucher is equal to £50. Childcare vouchers are exempt from tax and class 1 national insurance contributions up to £55. That is why in this case the payable tax and National Insurance contributions apply to £300 and not to £350, as the employee has agreed to sacrifice £50 of his total salary.

Want to know about Childcare vouchers? Please refer here to our jargon-free guide

Following is a numerical example from the salary sacrifice calculator of the saving in employer and employee taxes and NI;

Before salary sacrificeAfter salary sacrifice
Gross salary£15,000£14,100
Personal allowance£12,570£12,570
Taxable income£2,430£1,530
Income tax£486£306
Employee NI contribution£292£184
Employer NI contribution£814£690
Employee pension contribution£900 
Employer pension contribution£750£1,650
Pension contributions£1,650£1,650
Net take-home pay£13,502£13,610
Change in net take-home pay £108

Key considerations of a salary sacrifice scheme

It is important to note that:

  • Not all kinds of non-cash benefits are exempt from payable tax and national insurance contributions.
  • Salary sacrifice should not decrease an employee’s cash earnings to a level below the National minimum wage rate.

If you are interested to know about tax-free benefits, please read our guide on benefits in kind

Benefits exempt from Tax and National Insurance Contributions

Pension salary sacrifice: Employees sacrifice a part of their salary, allowing it to be paid directly into their pension schemes. This scheme increases their pension contributions while reducing their tax payments.

Cycle to work scheme

Cycle to work scheme allows an employee to buy a bike without paying for it all at once. Instead, they can pay for it over a period of a year. As taxable income is reduced, the employee can save on the cost of a bicycle and its accessories depending on the price of the bike and their tax bracket.

To find more information on cycle to work, please read our guide “Is the Cycle to Work Scheme Right for You?”

Electric Vehicle (EV) salary sacrifice scheme

Under Electric Vehicle (EV) salary sacrifice scheme, an employee can have and drive a fully electric car by foregoing a part of their salary. This deduction is applied before the application of tax and NI on an employee’s salary.

Workplace nurseries

In this scheme, employers offer their employees childcare support in exchange for salary deductions. This scheme works through on-site nurseries or allowing the employees to choose from a selection of childcare providers.

Childcare vouchers

Though closed in October 2018 for new applicants, but it can continue for those who adopted this scheme before this date. These vouchers, usually in paper or electronic form, are a salary sacrifice for working parents and allow them to save on their payable tax and national insurance contributions.

Restrictions on benefits

Since April 2017, some restrictions have been made on the eligible benefits in the salary sacrifice schemes by the Government of the UK. As a result, mobile phones and gym memberships are no longer included as benefits in salary sacrifice schemes.

Conclusion

In conclusion, the salary sacrifice scheme offers significant advantages for both employees and employers in the UK. For employees, it provides an opportunity to enhance their earnings by reducing tax liabilities and increasing take-home pay. They can utilize salary sacrifice to contribute towards pensions, childcare, cycle-to-work schemes, and more, thereby optimizing their financial well-being.

On the other hand, employers can benefit from implementing salary sacrifice schemes by streamlining their payroll processes and offering attractive employee benefits. By providing these schemes, employers can attract and retain top talent, boost employee satisfaction and engagement, and potentially reduce their National Insurance contributions.

Overall, the salary sacrifice scheme in the UK presents a win-win situation for both employees and employers, offering a valuable means to optimize earnings, reduce tax liabilities, and create a more rewarding work environment.

Supercharge your tax-saving potential with our expert accountants at Fusion Accountants who will guide you on a salary sacrifice scheme. Contact us now.