A salary sacrifice scheme for employees is where an employee gives up part of their salary in exchange for a benefit. The benefit may be additional pension contributions, childcare vouchers, healthcare for their family members, gym memberships, charitable donations, training or a something like a bike, as part of the cycle to work initiative.
Salary sacrifice schemes for employees are also known as salary exchange schemes.
How does salary sacrifice work for employees?
The salary sacrifice - the part of their salary employees are giving up in exchange for the chosen benefit - is taken from their gross salary, before tax. This means that the employee will pay less Income Tax and National Insurance (‘NIC’). The employer will also reduce their National Insurance Contributions bill. in return for the financial sacrifice, the employee will receive the commensurate value in a benefit as the money deducted from their gross pay.
Many large employers offer a salary sacrifice for employees as it’s a method of reducing tax and National Insurance contributions for their employees, whilst providing useful benefits and helping them build resilience for the future. It also means that employees have more money in their pockets when they're paid their salaries because they have less tax and NIC deducted from their salary.
Salary sacrifice – especially in the case of pensions – drives better financial resilience for the future. The scheme supported and recognised by HMRC.
Research by the Chartered Institute of Personnel and Development (CIPD) has found that only 41% of small to medium enterprises (‘SMEs’) offer salary sacrifice benefits for employees compared with 61% of large companies and 85% of very large organisations.
Salary sacrifice for employees must not reduce their cash earnings below National Minimum Wage (NMW) rates. Employers must have a series of checks and balances to make sure lower-paid employees have salary sacrifice deductions capped to ensure that employees are still paid above NMW.
Salary sacrifice schemes work better for higher paid employees rather than lower-income workers or those close to the income tax threshold. For 2024/2025 tax year, the threshold is £12,570. The reason for this is that those close to the threshold aren’t paying much tax anyway, so the potential savings aren't as great. A scheme to reduce tax for employees is not beneficial for those who are already paying little or no tax. A sensible rule of thumb for employers is not to accept any employee who is paid below the National Living Wage ('NLW') onto a salary sacrifice scheme.
What are the benefits of Salary Sacrifice for employees?
The main benefit to employees of salary sacrifice schemes is that they can buy additional benefits out of their untaxed income. Once they've 'bought these benefits, the balance of their pay gets taxed, so they pay less tax and National Insurance overall. By investing in a salary sacrifice benefit scheme, they may create better financial resilience for the future, improve their health and/or reduce their carbon footprint.
The government sees these reasons as advantageous as these benefits, taken now, may relieve the burden on organisations like the National Health Service in the future.
Buying out of un-taxed income means that employees don’t pay income tax or National Insurance on the money that funds the purchase. This means they can buy more compared to buying it out of taxed income.
The overall result of using a salary sacrifice scheme is that employees get more for their earnings.
What are the benefits to employers of Salary Sacrifice?
The main benefit to employers of implementing a salary sacrifice scheme for employees is that they'll pay reduced National Insurance contributions. The reason for this is that the benefits are purchased pre-NIC deduction, so the taxable amount for both parties is less.
Employers will pay less employer NICs - saving 13.8% on the sacrificed amount. In monetary terms, this will vary based on the employee headcount and the number of employees who participate in the salary sacrifice scheme, as not everyone will opt in to a salary sacrifice scheme.
Offering a salary sacrifice scheme for employees also demonstrates that the employer is mindful of the wellbeing of their team. This can also increase employee loyalty to the company and improve employee satisfaction.
How do I implement a salary sacrifice scheme?
Implementing a salary sacrifice scheme means a contractual change for employees. It’s therefore imperative that employers engage with their employees first to communicate the benefits of the scheme and seek the agreement of those employees who would like to take advantage of the proposed benefit. Employees can opt in, but they don't have to.
To do this, employers should have a consultation period where the scheme is fully explained and the employees can ask questions and have any concerns addressed. If changing the pension scheme, employees with over 100 employees are recommended to have a 60-day consultation period. For companies with less than 100 employees, the minimum recommended consultation period is 30 days.
The most common concern among employees is that when they read ‘sacrifice’ they think they are losing money. In reality, many employees end up having more money in their salary, even with the ‘sacrifice,’ as they are paying less tax and NICs. It’s critical that this is communicated effectively.
Employees may also have concerns that opting into a salary sacrifice scheme may affect their ability to borrow money – such as for a mortgage or loan. Lenders, however, take salary sacrifice into account as employee earnings. They often look upon salary sacrifice favourably as it demonstrates that the employee – particularly in the case of pension salary sacrifice – is building financial resilience for later life. Gross pay is still displayed on the employees online payslip and the breakdown is clearly shown so mortgage providers and lenders can see the financial breakdowns of salary sacrifice on payslips.
Employers must engage with their HR team or HR advisors to change the terms and conditions of employment as well as ensuring that NMW and national living wage regulations are adhered to. They need to make sure that employees don’t sacrifice below the primary threshold as this would affect their entitlement to other benefits. Employers need to have procedures in place to do this.
Benefit providers can help during this process as they will often have the appropriate employee communication materials to ease the consultation process and explain the benefits of the scheme.
Setting up a salary sacrifice scheme for employees is very easy. Providers of benefits that can qualify for salary sacrifice offer full support. They also have the necessary technology available to connect to payroll providers.
How does PayCaptain help?
PayCaptain has salary sacrifice functionality built into the outsourced payroll solution, so this can be offered to employees. Integration with benefit providers for things like pension schemes, childcare and healthcare, purchasing of bikes or low emission cars and others is quick, effective and seamless for employers who'd like to offer thee benefits to their employees.
In summary, salary sacrifice, also known as salary exchange, is a practice that’s supported by the government and employees are offered tax benefits to use it. The overall result of using salary sacrifice is that employees get more for their earnings whilst gaining from the benefits available.
To learn more about how PayCaptain can help your business and improve the financial wellbeing of your employees, please contact us for an informal chat. We’ll be happy to demo PayCaptain for you.
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