Pension contributions are one of the most common uses of salary sacrifice schemes. Cycle-to-work schemes and childcare vouchers are two more prevalent types of non-cash benefits (although the latter schemes are now winding down).
This brief provides a comprehensive overview of how the salary sacrifice scheme works and the important issues to be aware of. It specifically addresses the thorny topic of maternity leave.
What is Salary Sacrifice?
As part of their pension plan, your company may provide you with the option of salary sacrifice. This is a technique to make your pension savings more tax-efficient, perhaps increasing your take-home pay.
If you choose this option, you and your employer will agree to cut your salary, and your company will pay the difference into your pension together with their contribution to the scheme.
Because you’re effectively earning a smaller salary, you and your employer both pay lower National Insurance contributions (NICs), which typically means your take-home pay is higher. Even better, your employer may contribute some or all of their NIC savings to your pension (though they are not required to do so).
Salary sacrifice options differ since employers must choose whether or not to participate in a scheme. Check with your workplace to see if there is a salary sacrifice scheme available.
How Does Salary Sacrifice Work
Employees agree to forego (sacrifice) a portion of their salary in exchange for a benefit, in this case, pension contributions.
As an employer, you deduct the amount of your employees’ pension contributions from their salaries.
You then contribute to their employee pension savings an amount equivalent to their pension contributions plus your contributions.
As a result, you and your employees save money since you pay less for National Insurance on lower-paying jobs.
Do I Pay less Tax if I Make a Salary Sacrifice?
The salary you forego will not be subject to tax or National Insurance contributions under the following salary sacrifice schemes:
- Employer-provided childcare
- Bikes
- Vehicles with ultra-low emissions, including company automobiles
- Pensions
- Courses in retraining and outplacement services
- Intangibles, such as purchasing more yearly leave
By virtually foregoing a portion of your salary, you minimise the amount you get paid, which reduces the amount of income tax and National Insurance you pay. Your employer’s National Insurance contributions will also be decreased.
This means that more of your money is spent on items that benefit you, such as your pension, and less is taken as tax.
Employees have been expected to pay tax and National Insurance on any salary sacrifice or flexible benefit schemes they participate in since April 2017.
Employees who registered in a vehicle, housing, or school fee salary sacrifice scheme before April 6, 2017, are protected until the conclusion of the agreement, or until April 5, 2023, whichever comes first.
If the benefits you receive are taxable, they may be documented on your P11D form, which your employer must submit to HMRC each tax year. You should have a copy by the 6th of July.
While you may not save money on taxes under these alternative schemes, you will most likely profit from lower corporate rates. You can also buy high-value products outright that you would not be able to afford otherwise.
Salary Sacrifice can help you Increase your Pension.
You can lower your income tax and National Insurance (NI) contributions by allocating a portion of your salary to your pension instead.
In the illustrated situation, the employer would save on NI contributions and could be persuaded to transfer these savings to the pension contribution, increasing the amount paid towards your pension even more.
How it works
Here’s how salary sacrifice may work for someone earning £25,000 in 2021-23, with employees contributing 5% and companies contributing 3% to a personal pension fund. The current auto-enrollment contributions are reflected here.
The company reduces the employee’s salary by £1,000 while increasing the employee’s pension contribution by the same amount.
While giving up £1,000 may seem like a lot of money, you’ll be losing less than £70 per month (as a basic-rate taxpayer) over the course of a year, which might make a considerable difference to your pension account when you retire.
Please keep in mind that the following example just depicts the effects of income tax; National Insurance contributions will also be considered.
Maternity leave and salary sacrifice
As previously stated, maternity pay and SMP will be computed using the lower salary number. If the employee is entitled to contractual maternity pay, this may or may not be affected, depending on whether the company calculates using the notional salary figure or the decreased cash salary figure.
To comply with current regulations, employee benefits must be provided throughout ordinary and additional maternity leave (i.e., for the entire 52-week duration of leave). Previously, benefits were only available for the 26-week term of conventional maternity leave (OML).
This means that if a salary sacrifice scheme is in place, the non-cash benefit that the employer has promised to provide must be provided throughout the entire maternity leave period. This is true even if the woman is no longer entitled to pay. However, there is some disagreement regarding whether this also applies to pension salary sacrifice agreements and childcare voucher schemes (see further below).
Pension Salary Sacrifice During Maternity Leave
The pension salary sacrifice scheme is identical to other salary sacrifice agreements in every way except for the position during unpaid extra maternity leave (AML) (weeks 27 to 52 of maternity leave, with SMP normally being payable for up to 39 weeks).
Employer pension contributions shall continue throughout OML and any paid term of AML at the same rate as before leave, based on the employee’s actual salary, according to social security legislation. Any matching pension contribution made by an employee must be based solely on the wages they are receiving at the time (e.g., SMP).
In general, benefits granted through salary sacrifice plans continue throughout the entire maternity leave. However, there is a provision in the maternity statute for “employment-related benefit schemes” (which would include normal pension contributions). It appears that the goal was to leave the employer’s social security duties unaltered, such that pension contributions are only required during OML and paid during AML.
As a result, employers would not be required to continue making pension contributions during unpaid AML (i.e. the last 13 weeks of the maternity leave period). Both the Department for Business, Energy, and Industrial Strategy and HMRC appear to agree on this point.
However, the situation is far from clear. There is some debate over whether the Act correctly implements European law, therefore, it could be challenged. There is also some doubt about whether the exception meant to maintain the current situation on pension contributions may legitimately trump the duty to continue providing benefits during maternity leave.
Childcare Vouchers and Salary Sacrifice
Some workplaces allow parents to trade a portion of their salary for tax-free childcare vouchers; this scheme stopped new applications in October 2018, although existing claimants can continue to use the service for as long as their employer provides it, or until they change jobs.
You can choose your own childcare or nursery if you are eligible for the scheme, but they must be state-registered or Ofsted-approved. You hand the coupons along to your childcare provider.
The government has established tax-free daycare as an alternative to childcare vouchers.
Bikes and Salary Sacrifice
Many firms allow their employees to participate in Cycle To Work programmes in order to save money on the purchase of a bicycle.
You begin by selecting the bike you desire. Your employer purchases the bike and leases it to you. Many employers are able to reclaim VAT and pass this savings on to you.
The net cost of the bike for the hire term will be deducted from your salary.
When the hire time expires, you can purchase the bike from your employer at a ‘fair market value’ determined by HMRC.
This is 25% of the bike’s original worth after one year for bikes costing more than £500, or 18% of the bike’s original value for bikes costing less than £500.
If you rent the bike for more than a year, you can buy it for less.
This strategy also allows you to avoid paying tax and National Insurance on the portion of your salary that you sacrifice, resulting in substantial savings.
What are flexible benefit plans?
Some employers offer flexible benefit packages that enable employees to purchase additional or different benefits than those that the employer typically offers.
For example, you may get supplementary life insurance or critical illness coverage, or you could extend benefits such as private health insurance or health screening to your partner. You can also choose to ‘purchase’ more vacation time or, if you choose, to forego vacation time in exchange for extra income.
These schemes, often known as ‘cafeteria benefits’ or ‘flex plans,’ allow employees to tailor their compensation and benefits package to their own needs.
Because your employer may buy in bulk, you may be able to obtain benefits such as additional life insurance or critical illness coverage at a lower cost by purchasing through your workplace.
Intangible benefits, such as yearly leave, can be obtained without paying tax or National Insurance on that portion of your salary.
The Drawbacks of Salary Sacrifice
It is vital to examine the following potential drawbacks:
- If your workplace provides you with life insurance, it is normally calculated as a multiple of your salary. If you sacrifice some of your salary, your employer may provide less life insurance. Your company should inform you whether any workplace life insurance is based on your payment before or after the salary sacrifice deduction.
- If you leave a defined benefit plan within the first two years, you may not be able to claim a refund of your contributions. This is due to the fact that any salary sacrifice contributions would be considered employer contributions.
- If you’re in a defined contribution programme, you can only claim a refund if you opt out or leave the scheme within 30 days of entering it. Because your company will make these contributions, if you opt-out or leave after 30 days, your pot will remain invested and you will not be able to access the money until you reach the age of 55. (57 in 2028).
- Your lower salary may limit the amount of money you can borrow for a mortgage.
- Your eligibility for some state benefits, such as Statutory Maternity Pay, may be jeopardised.
So, if your business provides a salary sacrifice plan, consider whether it’s a good fit for you.
Your employer should explain how salary sacrifice will affect you and whether they will pay some or all of the NICs they save into your pension account.
Salary sacrifice is a legally binding agreement.
Salary sacrifice entails a change in an employee’s employment contract. When you put up a salary sacrifice plan, your current employees must agree to it.
If there is a substantial change in their lifestyle that affects their financial condition, you can set up your salary sacrifice scheme so that employees can opt in or out, agreeing to the change to their contract of employment each time (such as marriage, divorce, or bereavement).
Remember that salary sacrifice is governed by labour law rather than tax or pension legislation. If you are changing work contracts, you may need to seek professional guidance.
You might think about not enrolling some employees in your salary sacrifice plan if it will put them in a worse financial situation.
Employees cannot be included in a salary sacrifice plan if their earnings fall below the National Minimum Wage. You must have a method in place to check this.
Salary Sacrifice FAQs
How much can an employee salary sacrifice?
Salary sacrificed super contributions is made in addition to your employer’s mandatory super contributions, which are presently 9.5 percent of your salary. There is no upper limit to how much you can contribute to super through salary sacrifice. It is, nevertheless, critical to examine your concessional contribution cap. This is presently valued at $25,000.
What happens if I salary sacrifice more than $25000?
You can contribute more than the limits, but you should be aware that the excess amounts may be subject to further taxation. If you exceed your concessional contribution cap for the year, you may be required to pay your marginal tax rate on the excess amount rather than the concessional rate of 15%.
Does salary sacrifice affect tax return?
Salary sacrifice is a pre-tax payment from your paycheck to your super account that allows you to have more money in retirement. The amount you select is deducted before you are paid, lowering your taxable income and providing an instant tax benefit.
