Cash remuneration is one way to attract employees and reward them for their hard work – but it’s not the only way.
A range of non-cash benefits in the form of salary sacrifice schemes exist that you can take advantage of as a great incentive to attract and retain employees.
In this article, we break down what your options are, how they affect tax calculations, and the advantages and disadvantages for both you and your employees in entering into these arrangements, so you can feel confident in your choices.
Here’s what we cover:
- What is salary sacrifice?
- How does salary sacrifice work?
- What salary sacrifice schemes are available?
- What does salary sacrifice mean for tax and National Insurance contributions?
- Advantages of salary sacrifice for employers and employees
- Disadvantages of salary sacrifice for employers and employees
- Salary sacrifice FAQs
- Final thoughts on salary sacrifice
What is salary sacrifice?
Also known as salary exchange, salary sacrifice an agreement between you and your employee to reduce their pre-tax annual salary in return for receiving a non-cash benefit, i.e. goods or a service.
Most commonly employers offer childcare, healthcare, transport, and increased pension contributions.
These benefits are voluntary and employees are able to opt in and opt out of the schemes.
Most salary sacrifice schemes such as the Cycle to Work scheme must be offered to all employees.
So you’ll want to set up a robust HR process to ensure contracts are updated, and the correct information is provided to payroll.
How does salary sacrifice work?
Before you enter into an agreement, you’ll first need to agree on the cash value of the benefits to ensure the employee is fairly compensated for their loss of income.
The arrangement must not reduce your employee’s cash earnings below the National Minimum Wage (NMW) rates.
So you must put procedures in place to cap salary sacrifice deduction and ensure NMW rates are maintained.
To give an example, let’s say your employee’s current contract provides for cash remuneration of £40,000 a year with no benefits.
You both agree that for the future, the employee will be paid cash remuneration of £35,000 a year, and you will pay an additional £5,000 to their workplace pension scheme.
The employee has sacrificed £5,000 of annual salary to receive the benefit of an increased £5,000 employer pension contribution.
What salary sacrifice schemes are available?
Known as the Cycle to Work scheme, in essence, your employee hires a bike for the period of the agreement. The bike must be owned by you or a third party.
To simplify the process, there are plenty of scheme providers in the UK you can register with, and the employee will deal directly with them in choosing the bike they want.
There’s no limit on the value of the bike under the scheme, unless you decide to cap it.
At the end of the hire period there are a few options for the employee:
- Enter into a new agreement to rehire the bike
- Buy the bike from the scheme
- Give the bike back.
Similar to the bike scheme, employees can sacrifice a fixed amount of their salary each month in exchange for a brand-new lease car.
The set monthly amount usually includes the essential extras that come with car ownership such as road tax, insurance, breakdown cover, servicing and maintenance.
Your business doesn’t own the car, the employee is simply borrowing it from the lease company.
The leasing company remains the registered keeper of the lease car, and it’s returned at the end of the term.
For employees who take part in the workplace pension scheme, you must contribute a minimum of 3% employer contribution, though you can choose to contribute more.
One option to increase contributions is through a salary sacrifice pension scheme.
It means that your employer contributions increase, except that they are really the employee’s contributions, because their salary is proportionately reduced.
There isn’t a specific limit to how much the employee can sacrifice.
But as we mentioned earlier, your employee’s reduced salary has to remain above the national minimum wage.
You also need to bear in mind that each person can only contribute a total of £40,000 to all pension savings annually (this is the case for the 2022/23 tax year; it’s been frozen at this figure for a few years).
This includes employer contributions, so make sure the higher contributions from their salary sacrifice doesn’t push them over this.
It’s also helpful to check the minimum and maximum contributions allowed by the pension provider.
Unfortunately, this scheme is closed to new applicants (they can now access Tax-Free Childcare), but you can continue to run the scheme for employees who joined on or before 4 October 2018.
Employees who are part of the scheme can sacrifice up to £55 a week of their salary in return for vouchers of the same value to be used with registered childcare providers.
What does salary sacrifice mean for tax and National Insurance contributions?
Because salary sacrifices are deducted from pre-tax salary, this means employees save income tax and National Insurance on the sacrificed amount.
Let’s say, for example, they receive £350 per week, and £50 of that salary is sacrificed for childcare vouchers of the same value. The outcome is only £300 is subject to tax and National Insurance contributions.
Employer savings relate to employer National Insurance rates.
Generally, employers contribute 15.05% to National Insurance and can therefore generate up to 15.05% savings on any funds processed via salary sacrifice.
For example, for every £1,000 spent on the Cycle to Work scheme, the average employer will recoup £150.50.
You also need to consider that reporting requirements for non-cash benefits are different to those for cash earnings.
In general, benefits must be reported to HMRC at the end of the tax year using the end-of-year expenses and benefits online form.
Advantages of salary sacrifice for employers and employees
As we mentioned above, the common benefit across schemes is that employees can take advantage of the exemption from income tax and National Insurance on the sacrificed amount.
Salary sacrifice schemes also make high-priced items such as a car or bike more affordable by allowing your employees to spread the cost.
Paying for these items in monthly instalments that come straight out of their salary is much more manageable than paying one lump sum upfront.
They can also use these benefits for business and personal use.
This means as an employer, you don’t need to pay business mileage since the employee is no longer using their personal car for business travel, so they won’t be claiming business miles.
The same benefits also reward employers because the schemes help to attract staff and increase employee retention. In addition, employers save on tax costs because there’s no employer National Insurance contribution to pay on the portion of sacrificed salary.
Disadvantages of salary sacrifice for employers and employees
As salary sacrifice schemes essentially reduce the employee’s salary, this could impact any credit or mortgage applications.
It also means that work-related statutory payments (payments paid by the employer and based on average earnings over a fixed period, such as statutory maternity pay and statutory sick pay) will be affected too.
For a car leasing scheme, the employee will need to pay Benefit in Kind (BIK) tax at the end of the year.
If the leased car is not an ultra low emission vehicle like an electric car, they could end up paying more on BIK tax than they would save on income tax and National Insurance contributions.
For employers, complications can arise when staff turnover is high.
If your employee leaves during the lease term for a car, for example, the business is left with the ongoing monthly payments, or an early termination charge for ending the lease early.
Salary sacrifice FAQs
Here are the answers to frequently asked questions about salary sacrifice:
Can employees opt in and opt out of salary sacrifice schemes?
Yes, salary sacrifices are voluntary.
If an employee wants to opt in or out of a salary sacrifice arrangement, you must alter their contract with each change. Your employee’s contract must be clear on what the cash and non-cash entitlements are at any given time.
Therefore, sacrifice arrangements tend to be in place for at least 12 months, unless the employee experiences a lifestyle change.
In that case the arrangements would be reviewed, then adjusted or removed from the employee’s contract.
Does salary sacrifice appear on a payslip?
Yes, a salary sacrifice should appear on an employee’s payslip.
The sacrificed amount will be shown as a deduction made before tax and National Insurance are applied.
Can salary sacrifice be backdated?
No, a salary sacrifice cannot be backdated.
It’s only valid from the point you and your employee make the agreement, which is the date their contract is signed by both parties.
Can salary sacrifice be mandatory?
No, it’s a voluntary reduction to an employee’s salary, which must be agreed on by both employer and employee before it takes place.
Therefore, you shouldn’t automatically enrol employees in a salary sacrifice scheme.
Where can I find more details about salary sacrifice?
The government website covers information about salary sacrifice and what it means for employers and their employees.
There are details on numerous topics, including changing the terms of a salary sacrifice arrangement to what it means for workplace pension schemes.
You can also speak to a payroll expert or an accountant who offers payroll services.
Final thoughts on salary sacrifice
Once you have the processes set in place, a salary sacrifice arrangement is a win-win for both you and your employees.
In addition to tax savings and added convenience, they can also promote good savings habits, low emission transport choices, and a healthier lifestyle.
As an employer, you don’t have to offer every scheme but consider surveying your employees to find out which ones they feel they would most benefit from.
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