What is salary sacrifice?
Giving up part of your pay every month might sound like a strange idea, but it can make financial sense.
Salary sacrifice enables you to exchange part of your salary for a non-cash benefit from your employer, such as increased pension contributions.
Salary sacrifice is commonly used to boost your pension, but you can also give up salary in return for benefits such as bikes, mobile phones and bus passes.
Salary sacrifice options vary, as employers must choose to opt into a scheme. Check with your employer to see which salary sacrifice schemes are on offer – if any.
How do salary sacrifice schemes work?
You’ll sign a salary sacrifice contract with your employer, where you agree to forgo a certain amount of pay in return for certain benefit.
The amount can vary depending on what the salary sacrifice is for, and what terms your employer has in place.
You can usually change the amount of money you sacrifice, but this has to be agreed with your employer.
You can opt out of salary sacrifice at any time. But if you were using it to finance something you own - for example, a bike or mobile phone - you will still need to pay off the outstanding amount.
Do I pay less tax with salary sacrifice?
Under the following salary sacrifice schemes, the salary you forgo will not be subject to tax or National Insurance contributions:
- employer-provided childcare
- ultra-low emission vehicles, including company cars
- retraining courses and outplacement services
- intangibles e.g. buying additional annual leave
By essentially giving up a portion of your salary, the amount you get paid is reduced – which decreases the amount of income tax and National Insurance you pay. The National Insurance contributions your employer makes will be reduced, too.
This means that more of your money is being spent on things that benefit you – like your pension – and less taken through tax.
Since April 2017, employees have been required to pay tax and National Insurance on salary they give up under any other salary sacrifice schemes or flexible benefit schemes.
Employees who enrolled in a car, accommodation or school fee salary sacrifice agreement before 6 April 2017 are protected until the end of the agreement, or 5 April 2021 – whichever is soonest.
If the benefits you receive are taxable, they may be recorded on your P11D form - this is submitted to HMRC by your employer each tax year. You should receive a copy of this by 6 July.
While you may not save on tax under these other schemes, you're likely to benefit from cheaper corporate rates. You can also buy high-value items outright you might not otherwise be able to afford.
Find out more: 35 ways to save on tax – a wealth of tips to save you even more money
Increasing your pension with salary sacrifice
You can reduce your income tax and National Insurance (NI) contributions by giving up part of your salary and directing it to your pension instead.
In the example shown, the employer would save on NI contributions and might be persuaded to add this saving to the pension contribution, boosting the amount paid towards your pension even more.
How it works
Here's how it might work for someone earning £25,000 during 2020-21, where employees pay 5%, and employers pay 3% of the salary into a personal pension scheme. This reflects the current auto-enrolment contributions.
The employer cuts the amount paid in salary by £1,000 but makes a corresponding additional contribution to the employee's pension fund.
While the thought of giving up £1,000 may sound like a lot of money, over the course of a year you'll be losing less than £70 a month (as a basic-rate payer) - it could make a significant difference to your pension pot when you come to retire.
Please note that the illustration above only shows the effects of income tax - National Insurance contributions will also be a factor.
Childcare vouchers and salary sacrifice
Some employers allow parents to exchange part of their salary for tax-free childcare vouchers - this scheme closed to new applicants in October 2018, but existing claimants can continue to use the service for as long as their employer offers it, or until they change jobs.
If you fall under the scheme, you can choose your own childcare or nursery, but they must be state registered or Ofsted approved. You pass on the vouchers to your childcare provider.
As an alternative to childcare vouchers, the government has introduced tax-free childcare.
You can find out more about how these schemes compare in our guide: tax-free childcare and other ways to save
Salary sacrifice and bikes
Many employers allow their employees to use Cycle To Work schemes to save money on the purchase of a bicycle.
You start by choosing the bike you want. The bike is bought by your employer, who then leases it to you. Many employers can reclaim the VAT and have the option of passing this saving on to you.
Your salary will be reduced by the net cost of the bike for the hire period.
Once the hire period ends, you can buy the bike from your employer at a 'fair market value' set by HMRC.
After one year, this is 25% of the bike's original value for bikes costing more than £500, or 18% of the bike's original value for bikes that cost less than £500.
If your hire period is longer than a year, you can buy the bike for less.
This scheme also allows you to avoid tax and National Insurance on the part of your salary you sacrifice, resulting in significant savings.
What are flexible benefit packages?
Some employers offer flexible benefit packages, which allow employees to buy extra or different benefits from the ones the employer offers as standard.
For example, you might choose to buy additional life insurance or critical-illness cover, or to extend benefits such as private health insurance or health screening to your partner. You can also choose to 'buy' additional holiday, or, if you prefer, give up holiday in return for extra cash.
These schemes are sometimes known as 'cafeteria benefits' or 'flex plans', as they allow employees to vary their pay and benefits package in order to suit their own personal requirements.
You may be able to get benefits such as extra life insurance or critical-illness cover more cheaply by buying through your employer, as your employer is able to buy in bulk.
Intangible benefits - including annual leave - can be purchased without needing to pay tax or National Insurance on that portion of your salary.
What are the downsides to salary sacrifice?
While the salary you’ve sacrificed is being spent on something of your choice, you’ll never actually see the money in your bank account each month.
A lower salary can affect entitlements like maternity/paternity pay, mortgage applications based on your income and some state allowances. However, it may mean you’re able to claim more tax credits.
You should also check with your employer to make sure your bonuses, pay increases and pension benefits won't be affected.
Salary sacrifice is unlikely to work for those on low incomes, as your take home salary is not allowed to fall below the national minimum wage.
Salary sacrifice: your questions answered
Are salary sacrifice contributions tax deductible?
Salary sacrifice contributions are not tax deductible.
Depending on the benefit you receive, the payments you make may reduce your taxable income - meaning your payments are essentially tax-free. This includes schemes for pensions, childcare, Cycle to Work, ultra-low emissions vehicles, retraining courses and intangible benefits.
There are certain schemes, however, that you still have to pay PAYE on. As there are so many schemes available, it’s worth checking about the specific one/s you are interested in with your employer.
How much salary sacrifice can I make?
Terms will vary between employers, but generally, you just have to make sure your take-home pay after salary sacrifice is more than the national minimum wage.
Keep in mind that only certain schemes will allow you to make the payments exclusive of tax and National Insurance.
Can salary sacrifice be backdated?
No, a salary sacrifice agreement is only valid from the date the contract is drawn up between you and your employer.
Can I use salary sacrifice if I have bad credit?
Yes – you do not have to undergo a credit check to enter into a salary sacrifice scheme, as the money is taken from your salary before it even gets to you.
However, depending on what you want to use a salary sacrifice scheme for, it might be advisable to pay off any debt you have before siphoning money for investments and non-essential items.
Can salary sacrifice be compulsory?
Your employer cannot force you to give up part of your pay for a salary sacrifice scheme – it should just be something that you can opt into.
However, the pensions automatic enrolment measures will mean that you are set up in a workplace pension scheme and a proportion of your pay will be put into that pension, along with a contribution from your employer.
While this is automatic and may seem compulsory, you have the option to opt out if you do not want to use your workplace pension scheme.
You can find out more in our guide to company pensions.
Can you salary sacrifice redundancy payments?
No – you receive redundancy pay as a lump sum payment from your employer, and it isn’t counted as pensionable earnings.
While you’ll still be subject to the same automatic deductions as your normal salary payments - meaning a set amount of your pay will still be put into your pension - your employer won’t have to match this.
Will salary sacrifice affect my state pension?
Salary sacrifice is not likely to affect your entitlement to the state pension, unless your lowered salary is under the threshold to make National Insurance contributions.
You starting amount for the state pension may also include a deduction if you were in certain earning-related pension schemes before 6 April 2016, or had certain workplace, personal or stakeholder pensions before 6 April 2012.
What other things can be claimed as part of salary sacrifice?
In addition to some of the options already outlined, certain employers may allow you to use salary sacrifice for:
- Gym membership
- School fees
- Annual leave
- Mobile phones and tablets
- Mortgage payments and rent
- Annual travelcards
- Share schemes
- Health screening checks
- Car parking near your workplace
- Work-related training
But keep in mind that some of these benefits may be taxable, so check with your employer and make sure you fully understand the benefit you're signing up.