Salary Sacrifice: An Employer’s Guide

3rd December 2015

Salary sacrifice (AKA salary exchange) schemes have been around for some time, but they can still cause confusion amongst both employers and employees.

In this guide we’ll look at the benefits and pitfalls, as well as the key practical considerations for you as the employer if you decide to go ahead and set one up.

What are the benefits of salary sacrifice schemes?

Done properly, a salary sacrifice scheme is a great way of giving your members of staff access to a non-cash benefit. In return they will need to give up part of their pre-tax salary – hence the name.

Popular examples of non-cash benefits offered to employees include:

Childcare vouchers
Cycle-to-work schemes
Company cars
Work-related training
Parking near your workplace
Additional employer pension contributions

It’s the final example – additional pension contributions – that we’ll be focusing on in this guide.

One of the main attractions of salary sacrifice arrangements is that employers and employees alike can cut their National Insurance contributions (NICs).

Indeed, as the employer you could save up to 13.8% on NICs, depending on the employee’s salary.

Key considerations for the employee

A salary sacrifice scheme can be a win-win, with both parties gaining, but there are some potential drawbacks that employees should be made aware of at the outset.

Their entitlement to certain state benefits (eg maternity and paternity pay, tax credits) could be affected – as could any redundancy pay
Getting a mortgage for their required amount could become more difficult, as lenders tend to look at the post-exchange salary

Key considerations for you as the employer

Statutory benefits (eg maternity pay, sick pay etc) cannot be exchanged
Sacrificing a worker’s salary to below the lower earnings limit (£5,824 per annum in 2015/2016 and 2016/2017) will affect their entitlement to all contribution-based state benefits
An employee’s earnings mustn’t fall below the National Minimum Wage as a result of salary exchange
HMRC won’t give its view on a salary sacrifice scheme until it has been implemented. Once it’s up and running, you can ask for the tax authority’s opinion as to whether everything has been set up properly.

Salary sacrifice pensions

Some employers choose to apply sacrifice arrangements to pension schemes. One option is to reinvest some or all of your NIC savings through an additional pension contribution.

This table* shows how an employee earning £30,000 a year stands to gain:

	Pre-exchange position	Post-exchange position	Benefit
Employer costs	£34,520	£34,520	–
Employee net pay	£22,287	£22,467	+£180
Total gross pension contribution	£3,000	£3,206	+£206

As you can see, the employee’s take-home pay is increased along with their pension contribution.

Salary sacrifice: pension bonus exchanges

The same principles applies to exchanges that can be set up for employees earning a bonus.

Here’s how someone on a salary of £80,000 could benefit from a pension exchange scheme if they receive a £20,000 bonus:

	Pre-exchange	Post-exchange
Salary	£80,000	£80,000
Cash bonus	£20,000	–
Personal allowance	£10,600	£10,600
Tax	£29,403	£21,403
NI	£5,261	£4,861
Net income	£65,336	£53,736
Employer NI	£12,681	£9,921
Employer contribution	–	£22,760
Effective tax relief on contribution	–	49%

Setting up a salary sacrifice scheme

Here are some key points to remember:

The terms of an employee’s employment contract must be formally updated for the scheme to be valid
A written explanation of the decrease in salary must be signed by both parties before the scheme takes effect
As the employer you can state how long you wish the scheme to be in place and whether or not an employee can opt in and / or out

Salary sacrifice and child benefit

A couple’s entitlement to child benefit is restricted where either of them has ‘net-adjusted’ income of £50,000-£60,000. It is lost altogether if one parent earns more than £60,000.

Salary sacrifice schemes represent a way of avoiding these high-income charges. Here’s how someone with annual income of £55,000 could benefit by agreeing with his employer to exchange £5,000 of their salary for an employer pension contribution from the start of the 2016/2017 tax year:

Income tax – £5,000 @ 40%	£2,000
Employee NICs @ 2%	£100
Employer NICs @ 13.8%	£690
Child benefit tax charge saving	£894.40
Total savings	£3,684.40

Salary sacrifice and high earners

Over the years salary exchange has been used to reduce a high earner’s adjusted net income so that the full personal allowance of £10,600 is available (increasing to £11,000 for 2016/2017).

From 6 April 2016 those with ‘adjusted income’ above £150,000 contributing to a pension scheme will see their annual allowance reduced by £1 for every £2 of excess adjusted income.

A new measure called ‘adjusted income’ will determine whether income exceeds £150,000. High earners will be prevented from using salary exchanges to avoid the restriction.

Salary sacrifice and pensions auto-enrolment

Auto-enrolment doesn’t mean the end of pension salary exchanges, but it’s vital to remember that enrolling employees into a workplace pension scheme can’t involve the employee having to make a choice.

There are still plenty of options open to employers. You could:

automatically enrol eligible jobholders on a non-salary exchange basis, allowing sufficient time for any opt outs to be processed before offering salary exchange to members as an additional benefit
postpone automatic enrolment for up to three months and invite employees to sign up for salary exchange during the deferral period
contractually enrol employees on a salary exchange basis – this could be done during a postponement period.