Salary sacrifice is a popular and legitimate method of saving tax in the UK—used by employees and employers alike to increase take-home pay and reduce National Insurance (NI) liabilities. But how does it actually work?
At its core, salary sacrifice is an agreement between an employee and employer to “give up” a portion of gross salary in exchange for a non-cash benefit. Because the sacrifice is made before tax and National Insurance are calculated, it can result in lower overall deductions—benefiting both parties.
How It Works
Let’s say an employee earns £40,000 a year and chooses to sacrifice £3,000 into their workplace pension. Their new gross salary becomes £37,000 for tax and NI purposes. The £3,000 goes directly into the pension scheme, and the employee pays less income tax and NI on their now-lower salary.
Employers also benefit, as their National Insurance contributions are calculated on the reduced salary. Some companies pass on these savings to the employee’s pension as an added incentive.
Common Salary Sacrifice Benefits
Pension Contributions: The most common and tax-efficient use.
Cycle to Work Schemes: Save on bikes and accessories through reduced salary.
Electric Car Leasing: Low Benefit-in-Kind rates make EVs a popular perk.
Childcare Vouchers (limited to those enrolled before October 2018).
The Tax Perks
Income Tax: Since the sacrificed amount is deducted before tax, taxable income is reduced.
National Insurance: Both employer and employee NI are reduced, increasing take-home pay.
Pension Efficiency: Contributions are typically higher and grow tax-free.
Important Considerations
Salary sacrifice isn’t suitable for everyone. Reducing gross income could affect:
Statutory Maternity Pay or Sick Pay eligibility
Mortgage affordability assessments
Certain state benefits
In addition, salary cannot be reduced below the National Minimum Wage through sacrifice.
Final Thought
Salary sacrifice can be a powerful tool for boosting pension savings and reducing tax liabilities. But it must be properly documented and agreed upon with your employer. As always, it’s wise to consult your HR department or a financial adviser to ensure it aligns with your personal circumstances.