Salary Sacrifice Explained
An arrangement where you give up part of your gross salary in exchange for a non-cash benefit. You save Income Tax and National Insurance on the amount sacrificed.
What is salary sacrifice?
Salary sacrifice (also called salary exchange) is a formal agreement between you and your employer where you accept a lower contractual salary in return for a benefit. Because your gross pay is reduced before tax is calculated, you pay less Income Tax and NI. Your employer also saves on employer NI.
The most common salary sacrifice arrangements are for pension contributions, Cycle to Work schemes, electric car leases, and childcare vouchers (closed to new entrants since October 2018).
How it works
Your employment contract is amended to reduce your gross pay. The difference goes directly to the benefit (e.g. your pension pot). Tax and NI are then calculated on your lower salary. Your take-home pay drops by less than the full sacrifice amount because of the tax savings.
There is one restriction: your salary after sacrifice cannot fall below the National Minimum Wage or National Living Wage. Salary sacrifice also reduces the income figure used for mortgage applications and some benefit calculations, so it is important to consider the full picture.
Real example
Nina earns £40,000 and sacrifices £3,000 into her pension. Her taxable salary drops to £37,000.
| Item | Without sacrifice | With sacrifice |
|---|---|---|
| Gross salary | £40,000 | £37,000 |
| Income Tax | £5,486 | £4,886 |
| Employee NI | £2,194 | £1,954 |
| Pension contribution | £0 | £3,000 (via sacrifice) |
| Take-home pay | £32,320 | £30,160 |
Nina's take-home drops by £2,160, but £3,000 goes into her pension. The £840 difference is her tax and NI saving. Her employer also saves £414 in employer NI (13.8% of £3,000), which some employers pass on as additional pension contributions.
Who does this affect?
Any employee whose employer offers a salary sacrifice scheme. These are most common in larger organisations. Higher and additional rate taxpayers benefit the most because the tax savings are proportionally larger. Employees earning close to the NMW may not be able to participate if the sacrifice would push their pay below the legal minimum.
HMRC source
gov.uk/guidance/salary-sacrifice-and-the-effects-on-paye covers the rules for salary sacrifice arrangements and which benefits qualify.
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