What is salary sacrifice? How do these schemes work?

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If you’re employed, your employer may offer salary sacrifice schemes – where you can give up some of your salary to pay for perks. What is salary sacrifice? How do these schemes work?

What is salary sacrifice?

Salary sacrifice sort of does what it says on the tin. If you’re an employee, your employer may let you give up some of your salary in exchange for a benefit. This can be something like a company car, extra pension contributions, childcare vouchers or gym membership.

  • The benefit to the employer is that they don’t have to pay employer’s National Insurance on the part of the salary that’s sacrificed.
  • The benefit to the employee is that they don’t have to pay tax or National Insurance on the part of their salary that they’ve given up.

SAVVY TIP: Salary sacrifice can’t be used to reduce your earnings below the National Minimum Wage or National Living Wage (if you’re 25 or over) rates.

What can you get through salary sacrifice?

You can use salary sacrifice to save money on a range of benefits. Examples include:

  1. Extra pension contributions
  2. Childcare vouchers – these are vouchers provided by employers for use with any childcare provider that accepts them.
  3. A company car – salary sacrifice can give employees a way of affording a new car on a leasing deal. It isn’t the best option for everyone.
  4. Income protection – this is designed to pay part of your income if you can’t work because you’re ill.
  5. Gym membership – this can involve reduced membership costs or a 12% National Insurance saving for basic rate taxpayers. The saving is just 2% for higher rate taxpayers.
  6. A mobile phone – there are several schemes that give employees access to subsidised handsets.
  7. Health screening – this can mean a saving of up to 42% on the cost of health screening, plus you can pay for it through the payroll.
  8. Training – the training must be work-related to qualify for salary sacrifice but the definition of ‘work-related’ is quite loose.
  9. A bicycle (through the cycle to work scheme) – according to Cyclescheme if you spend £600 on a new bike you can save around £72 on employee National Insurance.

Example of how salary sacrifice works

This examples is taken from the government’s .Gov.uk website. Say you have:

  • Earnings of £350 per week with £50 a week sacrificed. If you receive £50 a week of childcare vouchers, you’d only pay tax and National Insurance on £300 salary a week as you can get up to £55 a week in employee childcare vouchers.
  • Earnings of £350 a week with £100 a week sacrificed. If you take £100 a week of childcare vouchers, you’d pay tax and National Insurance on £295 of your salary (not £250, as you might expect). That’s because you can have £55 of childcare vouchers a week free of basic rate tax and National Insurance. You’d only pay tax on £250 through PAYE, but you would pay tax on the other £45 a week. This would be reported to HM Revenue and Customs at the end of the year using a P11D or P9D from.
  • A £5,000 bonus and you sacrifice it all. If your employer pays the £5,000 into your pension scheme, you wouldn’t pay any income tax or National Insurance on the £5,000 bonus.

The pros and cons of salary sacrifice

The benefits of salary sacrifice are fairly obvious: both you and your employer save money because of the reduced tax and National Insurance. But there are some disadvantages:

  1. Your salary sacrifice may affect the amount you can borrow if you apply for a mortgage. If you’re using a mortgage broker, ask them if all lenders take the same approach to salary sacrifice.
  2. If the amount you receive in pay falls below the level at which you pay National Insurance, it could affect your entitlement to state benefits such as statutory maternity pay.
  3. If your employer offers life insurance, the amount of cover you get may be reduced because your salary is lower.
  4. Normally, if you join your employer’s pension scheme and later move to a new employer, you can either leave the pension you’ve built up where it is or take it to your new job. If you leave within two years of joining your employer’s pension scheme, you may be offered what’s called a ‘refund of contributions’. As it sounds – it means you just get back the money you’ve paid into your pension. With salary sacrifice, you’re not paying money into your pension scheme (it’s being done by your employer) so you wouldn’t get the money back.

Changes to salary sacrifice schemes from April 2017

In the Autumn Statement, the chancellor announced that from April 2017, it will remove the tax and National Insurance advantages of salary sacrifice schemes, except for:

  • Pensions (including advice about pensions)
  • Childcare
  • Cycle to work schemes
  • Ultra low emission cars.

That means that there will be no advantage to employees to sacrifice their salary, unless it’s used for pensions, childcare costs etc.

SAVVY TIP: If you’re already part of a salary sacrifice scheme by April 2017, it will be protected until 2018 and arrangements for cars, accommodation and school fees will be protected until April 2021.

Related articles:

Your rights if you’re employed, self employed or a worker

VIDEO: Understanding how income protection policies work

Employee share schemes – owning shares through your workplace

Automatic enrolment into a workplace pension: what information can you expect?

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