What is salary sacrifice?

Salary sacrifice is a tax-saving arrangement where an employee sacrifices a portion of their pre-tax salary in return for a non-cash benefit.

But what are the benefits of salary sacrifice schemes? And is a salary sacrifice the right route for you? We’ve pulled together the following guide to walk you through everything you need to know.

What is salary sacrifice?

Salary sacrifice is an arrangement where an employee agrees to reduce their pre-tax salary in exchange for non-cash benefits. This can lead to savings on both tax and National Insurance (NI), benefitting both the employee and employer.

How does salary sacrifice work?

Your company may well offer salary sacrifice benefits such as cycle to work, childcare contributions, and a workplace pension. You pay for these benefits through your salary before tax, meaning the amount of income tax and National Insurance (NI) is reduced – potentially saving you money. It’s worth checking the ins and outs of the specific salary sacrifice schemes being offered by your employer as some only offer savings on NI.

When it comes to being able to take out a salary sacrifice benefit, there are some important rules to know:

• Salary sacrifice arrangements should never reduce an employee’s cash earnings below the National Minimum Wage
• Once both parties have agreed to using the salary sacrifice benefit, the terms of the employees’ contract must be officially updated

What can salary sacrifice be used for?

While we’ve mentioned a few examples already, there are various benefits you can access through a salary sacrifice scheme: These include:

• Pension contributions: A salary sacrifice arrangement is a popular way to maximise your pension contributions
• Childcare: Used for paying for licenced childcare
• Company car schemes: Some employers also allow you to lease a car through a salary sacrifice scheme
• Technology: Laptops, smartphones, and other work-related tech may also be available
• Cycle to Work: Purchase a bicycle which you intend to use for commuting

Benefits of using salary sacrifice

Using salary sacrifice has potential benefits for both employees and employers. Here’s a breakdown of some of the key advantages:

Benefits for employees

• Tax savings: As previously mentioned, since your taxable income is reduced, you’ll end up paying less income tax and NI. This means you'll get to keep more of your money while still receiving valuable perks. For example, using the Cycle to Work scheme can save 28% to 47% on the value of your chosen bike, depending on your income.
• Boosted pension contributions: The salary sacrifice scheme is a great way to grow your retirement savings. By paying into your pension before tax is deducted, you’ll be able to boost your fund (while also reducing your current tax bill). This is a great way to do something your future self will thank you for.

Benefits for employers

• Reduced  employer National Insurance: Employers may also benefit from reduced NI costs, as they won’t be required to pay tax on the sacrificed amount.
• Attract and retain employees: Salary sacrifice schemes may also attract potential employees, with many viewing the benefit as a valuable perk. This is a great way to stay competitive in the job market.

Are there any downsides to salary sacrifice?

While using salary sacrifice can be a great way to save on taxes and boost savings, there are additional things you’ll need to bear in mind before committing to one.

It’s worth noting that taking out a salary sacrifice benefit might affect an employee’s entitlement to other benefits that are calculated based on their salary, such as overtime pay or bonuses.

Equally, a lower salary may affect you when applying for loans, mortgages, and other credit products. For instance, it could make it more challenging to prove your income when applying for a mortgage. This is because lenders may only consider your reduced salary when assessing your eligibility.

Is salary sacrifice right for you?

Now that you’ve got a clear understanding of what salary sacrifice is, there’s only one question left – is it right for you? That all depends on your current situation, your priorities, and goals:

Maximising your pension contributions

If you’re focused on saving for retirement, it might be a good idea to leverage potential salary sacrifice savings when increasing your pension contributions. This allows you to take advantage of the tax relief while boosting your savings for the future. Check if your employer will match your contributions, as you’ll be able to save even more.

Benefit availability

Are there meaningful benefits being offered through the salary sacrifice scheme? If this includes items you would have purchased anyway, salary sacrifice might be a good way to save at the same time.

Short-term goals

If you’re struggling with your monthly budgeting, a salary sacrifice arrangement might not be the best option for you currently. Make sure to consider whether reducing your take-home pay is right for you in the short-term

Salary sacrifice: In conclusion

Salary sacrifice can be a great way to reduce tax burdens, increase savings, and access valuable perks. It’s particularly beneficial if you’re hoping to boost your pension.  However, salary sacrifice arrangements may not always be the right route for everyone.

If you’re looking to boost your current cash flow or you don’t see much value in the benefits on offer, salary sacrifice might not be worth it. So, take the time to understand whether salary sacrifice schemes align with both your current and future goals.

And if you’re looking for additional insights, you can head over to the Moneyboat blog. Read about everything from managing your personal cash flow to how to budget when you're paid weekly.