This guide is for financial advisers only. It mustn’t be distributed to, or relied on by, customers. It is based on our understanding of legislation as at March 2024.
The basics
Salary sacrifice reworks an employee’s remuneration in a more tax-efficient manner at no additional cost to the employee or employer but can help generate higher pension contributions or higher take-home pay as a result.
Basic facts
Employers pay National Insurance (NI) contributions on salary and bonuses. They don’t pay NI on pension contributions.
Salary sacrifice replaces NI-inefficient payments such as salary and bonus with NI-efficient payments such as employer pension contributions.
How it works
- An employee agrees unconditionally to give up future remuneration in exchange for a non-cash benefit such as an employer pension contribution.
- This is usually evidenced by an exchange of letters to formally alter the contract of employment.
- It can be used with salary and contractual bonuses. A contractual bonus is one that an employee is expected to receive if certain targets or objectives are met.
- There is no need to formally document the sacrifice of a discretionary bonus (this is a bonus that an employee isn’t expecting). An employer simply pays the equivalent amount as a pension contribution with no need for any documentation to record this.
Benefits of salary sacrifice
The amount of salary which is sacrificed won’t be subject to income tax or NI contributions. The NI savings which salary sacrifice generates can be used in the following ways:
- add the NI savings to the employee’s take-home pay – the pension contribution will remain the same
- add the NI savings to the pension contribution – the employee’s take-home pay will remain the same
- use the employee’s NI saving to increase their take-home pay and use the employer’s NI saving to increase the pension contribution.
Note that there is no obligation on an employer to pass on any of their NI saving to an employee’s pension plan – it’s entirely at the employer’s discretion.
Other points to be considered
Salary sacrifice isn’t suitable for everyone. You should think about:
- the impact on any other benefits that are linked to salary, for example death benefits or overtime although it’s still possible for the employer to use a ‘notional’ or pre-sacrifice salary for these benefits.
- mortgage lending that may be linked to actual salary received.
- statutory benefits which may be affected by a reduction in salary, e.g. statutory maternity and paternity pay.
It’s worth pointing out that HM Revenue and Customs’ guidance confirms a salary sacrifice arrangement can’t reduce an employee’s gross earnings below the National Minimum Wage or the National Living Wage (whichever applies), so salary sacrifice won’t be suitable for these employees. In addition, where employees earn less than the personal allowance, salary sacrifice will only result in an increased pension contribution where around 75% of the employer’s National Insurance saving is passed on to boost the pension contribution. At the other end of the pay scale, consideration needs to be given to higher earners who may be subject to the tapered annual allowance or who could be if they agree to the salary sacrifice arrangement.
How salary sacrifice interacts with automatic enrolment
This guidance is taken from the section on ‘Salary sacrifice’ in The Pensions Regulator’s automatic enrolment guidance on ‘Pension schemes’.
Salary sacrifice arrangements are separate from the automatic enrolment provisions, although an employer may run the two processes in parallel when complying with their employer duties under automatic enrolment.
An employer may ask an eligible jobholder due to be automatically enrolled if they want to put in place a salary sacrifice arrangement. Active membership of the employer’s scheme can’t depend on whether the jobholder agrees to the arrangement. If the eligible jobholder declines to set up salary sacrifice arrangement, the employer must automatically enrol them with an alternative method of contribution deduction.
Employers may choose to put in place a salary sacrifice arrangement before or after a jobholder’s automatic enrolment date. If set up before, an employer may use postponement to allow time to put the salary sacrifice arrangement in place. If set up after the automatic enrolment date, an employer will have to use a different method of payment for the initial pension contributions due from the automatic enrolment date.
An employer will need to take care to separate information relating to a salary sacrifice arrangement from any automatic enrolment information. It can be sent to an employee at the same time, but an employer mustn’t give the impression that the jobholder will only be enrolled if they agree to salary sacrifice.
For defined contribution schemes, the level of qualifying earnings used to meet the minimum contribution requirements should be based on the post-sacrifice level of salary.
The future of salary sacrifice
The tax and National Insurance benefits of salary sacrifice schemes were removed from 6 April 2017, meaning that amounts sacrificed are liable to the same tax treatment as cash income, with the following exceptions –
- Pensions (including pension advice)
- Childcare
- Cycle to Work
- Ultra-low emission cars