Salary Sacrifice

Offering employee benefits is one way to attract top talent to your company. You might wish to provide anything, from private healthcare and additional annual leave - to a gym membership. One way to do this is to use a salary sacrifice scheme.

A salary sacrifice scheme can be beneficial to your company. Not only could it help save money on tax and National Insurance contributions, but it could also improve employee morale and retention.

In this guide, we'll discuss what a salary sacrifice is, the different salary sacrifice schemes, and its advantages and disadvantages.

What is a salary sacrifice?

A salary sacrifice is a financial arrangement an employer offers to their staff. An employee will agree to sacrifice some of their salary to receive a non-cash benefit.

The “sacrifice” is then achieved by varying the terms and conditions of employment (relating to pay) in an employee's employment contract. 

For example, an employer pays for a worker's bike as part of a cycle-to-work salary sacrifice scheme. The employee agrees to salary deduction each month until the arrangement ends.

Once over, the employee can then buy the bike at a small percentage of the original value (e.g. 3%). Or, they can return it to their employer. But this is dependent on the flexibility of the scheme provider.

Why do employers offer a salary sacrifice arrangement?

There are several reasons why employers might offer a salary sacrifice arrangement (e.g. increased employee satisfaction). Let's explore them in more detail so you can see how salary sacrifice schemes could benefit your business.

Other benefits of salary sacrifice schemes include:

Tax savings

One benefit of offering salary sacrifice to employees is that both you and your employee could save money, and pay less tax. As your employee's salary is lower, it equates to lower National Insurance contributions, as well as less employment income tax.

Consequently, this often means your employees have a less taxable income and a higher take-home pay. But, this isn’t always the case as it depends on how the scheme is set up. Consult a professional to ensure the scheme benefits your company.

Access to non-cash benefits

Salary sacrifice arrangements provide non-cash benefits to employees, which they might not be able to afford otherwise. As a result, this could provide an increase in employee satisfaction.

This is because your staff are able to improve their livelihoods with a bike or even a car. Consequently, this could increase their overall happiness at work, as they know that your business is providing them with non-cash benefits.

Higher employee retention

Another advantage of salary sacrifice contributions is that it may increase employee retention, because staff can benefit from the arrangement that your business chooses to offer.

Staff will recognise not every company provides salary sacrifice arrangements. Moreover, it might even attract top talent to your business.

What salary sacrifice schemes can you offer?

There are plenty of salary sacrifice schemes you can offer in your business. And what you choose to provide should be a reflection of your employees' needs.

Examples of common salary sacrifice schemes include:

Workplace pension schemes

You can offer a salary sacrifice as part of your workplace pension scheme. Instead of a percentage coming out of your staff's pay each month (e.g. state pension), you and your employee agree to lower their gross salary. You then pay the difference into their pension pot along with your own pension contributions.

Unlike an ordinary workplace pension scheme, a salary sacrifice pension contribution could equate to more pension savings. Specifically, if you decide to use the money you save on paying less income tax as pension contributions.

Car ownership

Another scheme you might wish to offer to staff is car ownership. This is where you reduce an employee's pay per annum, and in return provide them with a car from a third party supplier. Unlike a company car, the employee is responsible for the car's maintenance, and owns the car at the end of the scheme.

However, the rules on salary sacrifice car schemes don't have the same National Insurance advantages. The scheme now requires the employee to pay income tax on either the value of the car, or the amount of salary sacrificed. Moreover, it only applies to electric and low-emission vehicles.

What are the drawbacks of a salary sacrifice arrangement?

A salary sacrifice arrangement can have several drawbacks. It's important you are aware of them so you can work out whether offering a salary sacrifice scheme is worthwhile.

The drawbacks are:

Negative impact on earnings-related benefits

Salary sacrifice arrangements may impact an employee's entitlement to earnings-related benefits. These other benefits might include:

• Statutory maternity pay.
• Statutory sick pay.
• Redundancy pay.
• State pension scheme.

This only occurs if a staff member's salary falls below the threshold to pay National Insurance contributions. For example, if they earn less than £123 a week.

Lower salary

Another drawback of offering a salary sacrifice arrangement is that it means employees have a lower salary. This could make it difficult for them to pay essential costs, such as rent, mortgage, or car payments.

Ensure you consider the effect salary sacrifice arrangements have on the salary of your staff. If an employee's take-home pay means they can't afford to live - it would be better to offer them more money instead. It’s important to listen to staff concerns as well before going ahead.

Decrease mortgage borrowing rates

Salary sacrifice schemes might impact your employees' credit. In a salary sacrifice arrangement, it's more difficult to prove how much employees earn to lenders.

This means that staff might only be entitled to a lesser mortgage and loan borrowing, as well as lower life cover.

How long is a salary sacrifice?

The length of a salary sacrifice depends on the scheme employees choose to enroll in. But typically, such arrangements disclose a minimum period of 12 months.

For example, if you were to offer a car in return for salary sacrificed, the arrangement could last two, three, or four years - depending on the cost of the car.

Does salary sacrifice have to be offered to all employees?

Yes, you must give all employees the option to enroll in a salary sacrifice scheme. Apart from those receiving National Minimum Wage (or close to it). In this instance, you would have to offer something comparable that would not drop the employee below National Minimum Wage.

Failure to do so could result in staff submitting discrimination claims to an employment tribunal. Ensure you don't automatically enroll employees in a salary sacrifice arrangement either. It's important you offer staff the choice to take part and make it clear they have control.

How to set up a salary sacrifice arrangement

Now you're aware of how salary sacrifice arrangements work, it's time to introduce it to your staff. It's important your employees are aware of the scheme's details. This includes informing them of the tax implications, how much employee contributions will be, and the non-cash entitlements available.

Let's take a look at the ways you can implement salary sacrifice arrangements effectively:

Consider the impact on your business

First, you need to consider if a salary sacrifice scheme is beneficial to your business. It might seem advantageous, but it won't be suitable for every employee scenario.

For example, if you employ staff on National Minimum Wage, you won't be able to lower their salary. And therefore, you won't be able to provide the scheme to your employees.

If your employees aren't on National Minimum Wage and you want to offer the scheme, consult HMRC to ensure your staff pay the correct tax and National Insurance contributions. You could even use a salary sacrifice calculator.

Ask employees and establish the terms

Next, you must ask your employees if they would like to participate in the scheme. Once they agree to participate in the scheme, it’s time to write the agreement within your employment contracts.

Since a salary sacrifice arrangement is optional, you should amend your contracts after staff decide to opt into them.

Ensure employees know about the impact of entering such arrangements. For example, they will pay less income tax and National Insurance contributions. But, this means they will have lower cash earnings.

Catch up with your employees

Once you've introduced the scheme to your employees, ensure you have an ongoing dialogue with them.

It might seem like a simple step, but getting their thoughts on the arrangement will let you know if it's worthwhile.

For example, you could have one-to-one meetings with your staff every month to see if they find the scheme beneficial.

Example of a successful salary sacrifice

To understand salary sacrifice schemes better, it's important you look at an example of instances where they work well. For example, a senior staff member is contractually entitled each year to a bonus - which is based on profits his employer makes.

The company’s year end is March and the accounts are finalised in September each year - informing employees of the amount of the bonus due. The employee is not entitled to receive the bonus each year until 31st December and is informed by letter on 31st October.

The letter informs the employee that he can choose between:

• Receiving the cash bonus; or,
• Giving up his contractual rights to the cash bonus in return for the company making an employer contribution to a registered pension scheme for his benefit.

The employee decides to take the second option and returns the completed documentation to his employer on 30th November. This is a successful salary sacrifice arrangement as the employee has salary sacrificed in return for a non-cash benefit.

Get expert advice on salary sacrifice from Peninsula

You must make the appropriate arrangements when choosing to offer salary sacrifice in your business. This includes calculating the correct tax and National Insurance contributions in an employee's salary, as well as establishing the terms of the employee's contract.

Failure to do so can have consequences for your company. These include paying incorrect wages, low staff retention, and even discrimination claims to an employment tribunal - if you fail to offer every employee a salary sacrifice arrangement.

Peninsula offers expert advice on salary sacrifice. Our teams offer 24/7 HR advice which is available 365 days a year. We take care of everything when you work with our HR experts.

Want to find out more? Contact us on 0800 029 4377 and book a free consultation with an HR consultant today.