A salary sacrifice arrangement is when you and your employer agree to reduce your pay in exchange for a particular benefit, often childcare, pension contributions or a company car.
As an employee, it’s entirely your decision whether you want to opt into salary sacrifice, and there are various pros and cons to consider first.
Read on to find out more about salary sacrifice so you can decide whether it could be right for you.
How do salary sacrifice schemes work?
If your workplace offers a salary sacrifice scheme, this gives you the option to trade some of your salary for a particular non-cash benefit or benefits.
These might include:
- Car parking
- Transportation (such as bikes, bus passes or company cars)
- Increased pension contributions
- Pension advice
- Workplace nurseries
- A mobile phone
Opting in or out of a salary sacrifice arrangement means your contract will need to be drawn up and signed again to reflect the changes.
Childcare vouchers were previously offered as part of a scheme that lasted until October 2018. This is now closed to new applicants, but current claimants can keep using it until they change jobs or their employer stops offering it. This has since been replaced by the government’s tax-free childcare scheme.
No matter how much your pay gets cut, it legally can’t go below the National Minimum Wage.
Do I still pay tax or National Insurance contributions on salary sacrifice benefits?
Salary sacrifice can be particularly financially attractive as you will not be charged tax or National Insurance contributions on the amount deducted, only on the actual pay you receive. This applies to the following kinds of benefits:
- Childcare provided by your employer
- Cycle to work schemes or ultra-low emission vehicles
- Pensions (including advice)
- Intangible benefits, such as extra days of leave
- Retraining or outplacement
Since 6 April 2017, all other kinds of benefits have been taxable. This includes cars that are not low-emission, accommodation and school fees. If you enrolled into a salary sacrifice agreement before this date, however, the benefits will remain tax free until the end of the agreement or 6 April 2022.
Taxable benefits may be recorded on a P11D form, submitted to your employer by HMRC each year. A copy is typically forwarded to you as well.
Increasing pension contributions with salary sacrifice
One of the most common salary sacrifice arrangements is to boost your pension pot using the pay you’ve given up.
As stated above, you do not have to pay tax or National Insurance contributions on the amount deducted. As employers make National Insurance payments for all of their employees, both you and your employer can end up saving this way. You’ll benefit because you’re reducing your pre-tax income to pay into your pension, so you’ll pay less income tax and National Insurance on your earnings, which may mean you end up with higher take home pay.
Your employer will also pay less National Insurance. They might agree to add the savings made from lower employer National Insurance contributions to the total pension contribution amount they pay you, but they aren’t obliged to do this.
Certain employers, as well as any personal or private pension scheme, will have what’s called a ‘relief at source’ arrangement. In this case, they will deduct your 80% pension contribution and send it to your pension scheme after taking income tax first. Your pension scheme then claims the remaining 20% directly from the government. In this case, you will have to contact the tax office or complete a self-assessment tax return to claim your extra relief if you are a higher or additional rate taxpayer. Find out more about pensions and tax relief in our guide How pension tax relief works.
It’s worth remembering that pension tax rates and benefits can change and are dependent on your personal circumstances so there are no guarantees that current rules will continue to apply in future. If you’re not sure about investing or how pensions work, it can be a good idea to seek professional independent financial advice.
If you’re considering getting professional financial advice, Unbiased is offering Rest Less members a free pension review. It’s a chance to have a qualified independent financial advisor (IFA) take a look at your pension arrangements and give an unbiased assessment of your retirement savings.
The review is free and without obligation, but if the IFA feels you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
Things to consider before agreeing to salary sacrifice
The main downside of salary sacrifice is, of course, simply that you will have a lower salary to live on. Some schemes allow you to specify how much of your salary will be exchanged. Either way, you should think carefully in advance about whether you will be able to get by on a reduced income.
Having a lower income can have other knock-on effects. For instance, if you have workplace life insurance, the entitlement will be lower as well, because this number is calculated as a multiple of your annual income. Read more in our article Do I need life insurance?
Similarly, the amount you can borrow when you apply for a mortgage is usually calculated using a multiple of your income, so a reduced salary will mean you can borrow less than you might otherwise have been able to.
Also bear in mind that if your income falls below the level at which you make National Insurance contributions this will have other effects. For example, if you have not paid 35 full qualifying years of contributions by retirement age then you will not usually qualify for the full amount of the new State Pension. Find out more about the State Pension in our guide How the State Pension works.
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