How to use salary sacrifice for your business
How to use salary sacrifice for your business
As an employer, keeping up with salary expectations when you’re recruiting for your business, as well as keeping valuable employees, can be a challenging task to balance. Offering a salary sacrifice scheme can be an effective solution where you’re able to adequately compensate and reward employees whilst reducing your own tax liabilities. This article will explain how salary sacrifice schemes work, the advantages and disadvantages, and what different types of schemes you can offer to your employees.
What is salary sacrifice?
Salary sacrifice is an agreement between the employer and employee where the employee forgoes a portion of their normal salary before tax deductions are made in exchange for receiving a non-cash benefit.
It is important to be aware of the distinct difference between salary sacrifice schemes and benefits-in-kind although there can seem to be some overlap. Before April 2017, many employers operated salary sacrifice schemes in exchange for a variety of different benefits from private healthcare cover to gym membership and more. These benefits would be paid for from the employee’s salary before tax deductions were made. However, from April 2017 onwards, the government restricted the number of benefits that could be offered through salary sacrifice schemes that would be exempt from income tax and national insurance (NI).
Today, employers are still able to offer benefits in exchange for salary (or in addition to an employee’s normal salary) but many of them will be liable to income tax and NI. Some benefits can be offered tax-free such as free Christmas parties for staff or free teas and coffees but they are not considered to be a salary sacrifice scheme as employees do not forego a part of their salary in exchange for these benefits. For the purpose of this article, our discussion on salary sacrifice schemes will refer exclusively to those which are approved by HMRC to be completely exempt from income tax and NI.
How does a salary sacrifice scheme work?
An employer must choose to offer a salary sacrifice scheme for a specific non-cash benefit. The scheme must be offered to all eligible employees and clearly outline what the benefit is to be received by the employee as well as how much of the employee’s salary must be exchanged.
If the employee agrees, a new employment contract must be written up and signed by both parties which includes the details of the salary sacrifice arrangement. It is important that the employee is able to freely opt-in and opt-out of the salary sacrifice scheme, but their employment contract must be amended each time to reflect this.
Once the employment contracts have been signed, the employer will begin to pay the employee at the deducted amount as agreed. The employee will then have access to the benefit from that point. The employee receives a reduced salary, the non-cash benefit, and begins to pay less income tax and NI due to the reduced salary.
How much salary can an employee sacrifice?
There is no fixed maximum that an employee can agree to sacrifice in a salary sacrifice scheme, however specific benefits may have their own individual rules. The general rule which must be adhered to is that through agreeing to a salary sacrifice scheme, the employee’s salary cannot fall below the legal minimum wage thresholds.
Where the salary sacrifice scheme is for an exchange of pension contributions then it is important to be aware of the maximum amount that can be put into a pension scheme each year before tax needs to be paid. The annual allowance for total pension contributions (including employer’s contributions and government tax relief) is £60,000 or the employee’s annual salary – whichever is less. Any amount that is put into a pension fund over this limit will be liable to income tax.
Who can use salary sacrifice schemes?
Anyone who is an employer running a PAYE scheme can set up a salary sacrifice scheme for their workers. Salary sacrifice schemes are not limited to those employers who operate as a limited company but are also available to sole traders and partnerships as well.
As mentioned, the salary sacrifice schemes should be offered to all eligible employees and cannot only be offered to senior members of the team or any other select groups. Eligible employees are those who are earning above minimum wage and where their salary sacrifice will not fall below this threshold once salary has been exchanged for the non-cash benefit. Full-time and part-time employees can enrol onto a salary sacrifice scheme, but contractors and freelancers should not be because they are not classified as employees.
What are the benefits of salary sacrifice for my business?
Salary sacrifice can benefit your business by reducing your Employer’s NI liability because the amount of NI that needs to be paid by you is based on your employee’s salary. If the employee’s salary is reduced, your employer’s NI will also be reduced.
Salary sacrifice schemes can also benefit your business by helping you attract new employees as well as keep existing employees happy. It can help you stand out against competitors who are also trying to hire new recruits and be seen as a valuable bonus to employees who already work for you, encouraging them to stay.
What are the benefits of salary sacrifice for my employees?
It may not be immediately obvious why an employee would agree to forego a part of their salary or what the advantage to them may be, however salary sacrifice schemes are often seen as a win win for both parties. The benefits of a salary sacrifice scheme for your employees are that, when they forego a portion of their salary in exchange for a benefit, their income tax and NI contributions are calculated based on their agreed reduced salary. Therefore, they’ll pay less income tax and less NI whilst still receiving a valuable benefit.
What are the drawbacks to salary sacrifice schemes?
There are little drawbacks to the employer offering salary sacrifice schemes to their employees apart from the minor increase in administrative duties required to set up the scheme, ensure it is running correctly through your payroll, and amending employment contracts.
For employees however, there are more practical and financial drawbacks to accepting a salary sacrifice agreement which you may wish to highlight to them so that they can fully consider their options. Where an employee agrees to enrol onto a salary sacrifice scheme, they may suffer from the following drawbacks:
- A reduction in statutory pay such as maternity pay. Statutory maternity pay is 90% of the employee’s average weekly earnings for the first 6 weeks, and then 90% of their average weekly earnings or £172.48 per week (whichever is lower) for the following 33 weeks. If an employee agrees to salary sacrifice, then their maternity pay will reflect and be calculated based on their reduced salary.
- A possible reduction in their state pension. This is more likely to affect those employees who work part-time. Although all employees must be earning at least the national minimum wage after salary sacrifice, this is calculated hourly. The NI thresholds are however calculated based on weekly earnings. It may therefore be the case that the employee is earning minimum wage per hour but is not working enough hours per week to earn the minimum weekly NI thresholds to be required to make contributions. This will reduce their entitlement to receive the full state pension unless they make voluntary contributions to top up any shortfall.
- Being limited to the amount they can borrow from lenders. If your employee is seeking to obtain a loan or mortgage, they may be prevented from borrowing more when on a salary sacrifice scheme. This is because lenders often calculate how much they’re willing to lend depending on an employee’s salary so, if this has been reduced, their access to higher loan amounts may become restricted.
What are the different types of salary sacrifice schemes?
There are three different types of salary sacrifice schemes which have been approved by HMRC as exempt from income tax and NI:
- Childcare vouchers or workplace nursery. The childcare voucher scheme allowed employees to sacrifice a maximum of £243 per month from their salary in exchange for childcare vouchers to be used to pay for registered childcare. The scheme since closed to new applicants in October 2018 and has been replaced with the new Tax Free Childcare Scheme, however those already enrolled onto the scheme can continue to use it so long as they remain eligible. An alternative to childcare vouchers is where the employer runs their own childcare nursery facilities. Employees can agree to sacrifice a part of their salary in order for their child to use these workplace facilities and the value of this will be exempt from income tax and NI.
- Cycle to work scheme. The cycle to work scheme was introduced in 1999 to encourage healthier commutes to work and reduce car emission air pollution. The employer agrees to purchase a bike (often of the employee’s choosing) and ‘hires’ out the bike for a period of time (usually 12 months) in exchange for a portion of the employee’s salary. At the end of the hire period the employee can choose to return the bicycle, buy the bike at a nominal fee, or enter into a new hire period. The employee enjoys the benefit of a new bicycle that can be used for leisure, although HMRC expects that at least 50% of the bicycle’s use will be for the purpose of commuting to work. An electric bicycle can be purchased via the cycle to work scheme as well as any cycling equipment such as helmet, bicycle lights or high-vis gear, but scooters or motorised vehicles are excluded.
- Pension contributions. Although employers are legally obliged to automatically enrol employees onto a workplace pension scheme, they are also able to offer a salary sacrifice scheme in exchange for pension contributions. This salary sacrifice scheme can further benefit the employee as it can increase their take home pay whilst without forgoing on the amount they wish to contribute to their pension pot. To illustrate:
Without salary sacrifice an employee earns £35,000 per annum. They contribute a total of £1,400 into a workplace pension scheme for the year (which gets topped up to £1,750 through tax relief at 20% for basic rate income taxpayers). The employer contributes £1,050 into the pension fund for the year. In total, the employee’s pension pot is £2,800 for the year. The employee’s NI liability is £2,691.60 whilst the employer needs to pay £3,574.20 in employer’s NI. The employee’s income tax is £4,486 (at 20% basic rate) and their take home pay is £26,422.40.
With a salary sacrifice agreement in place the employee earns £33,250 per annum. They contribute £0 into a workplace pension scheme for the year. The employer contributes a total of £2,800 for the year and so the employee receives the same amount into their pension fund as before. The employee’s NI liability is £2,481.60 and the employer needs to pay £3,332.70 in employer’s NI. The employee’s income tax is £4,136.00 (at 20% basic rate) and their take home pay is £26,632.40 which is an increase of £210 compared to the above. The employer saves £241.50 in NI.
Get help with salary sacrifice for your business
If you’re ready to set up a salary sacrifice scheme and need help administering this through your payroll then reach out to see how we can help. Our payroll service does much more and we can advise on other tax-saving allowances such as Employment Allowance as well as ensure you understand your ongoing compliance obligations with re-enrolment or re-declaration. Use our contact form to get in touch.