tax benefits of salary sacrifice

When you ask your employees if they would like to sacrifice some salary, there initial reaction will be ‘no don’t take my money!’ However, with auto enrolment pensions now being the norm, unless an employee opts out, the obvious and practical choice for a workplace pension is to sacrifice salary rather than the deduction taken form net pay due to the considerable financial incentives to do so.

In this blog we are focusing on how a salary sacrifice arrangement works for pensions but this can be used for other employee benefits including Childcare voucher, Cycle to Work schemes and additional holiday purchase.

The tax implications

Salary sacrifice is one of three arrangements that can be used as a form of tax relief on pension contributions. However relief doesn’t stop at Income Tax, the employee also receives National Insurance Contributions relief. If you haven’t read our previous blog about tax relief, we would recommend doing so.

Here’s how the employee tax relief on pensions contributions works in a bit more detail …

Instead of an employee contributing 5% of their salary and the employer contributing 3% towards the pension, under salary sacrifice the employee will sacrifice 5% of their salary and the employer will contribute the full 8%. This is classified as an employer contribution because they are paying the full contribution (including the 5% amount sacrificed by the employee)

In addition to saving income tax on the money sacrificed, the employee will save 12% National Insurance and the employer 13.8% National Insurance.

As the pension contribution is effectively an employer contribution, the employer can pay the full employers’ National Insurance saving into the employees’ pension pot. Some employers choose to pay the full amount in, fostering excellent employer/employee relations, others choose 10% or any other figure down to zero.

Let’s see how this works out for the employee

If the employee sacrifices £100 and the employer chooses to contribute the full employers National Insurance saving of 13.8% of the saving, the total contribution to the pension fund is £113. With tax and NIC savings this £113.80 payment will only cost the employee £68.

The extra savings may persuade some employees to sacrifice greater amounts and have more money paid into their pension.

However, there are a couple of things you need to be aware of –

An employee cannot sacrifice their wages below the minimum wage limit.

  • If the employee is a non-tax payer, they will not get any tax relief through this method which they would get under a relief at source arrangement.
  • As they will have a lower salary it may affect the amount of money they can borrow for a mortgage.
  • Often life cover that is offered to employees is a multiple of their salary so a salary sacrifice arrangement may affect that.
Written by Sam Wingfield
Published on November 1, 2019