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    Salary Exchange

    Salary Exchange or Salary Sacrifice is often misunderstood by employers and employees, but it can be a powerful benefit for both parties.

    What is salary sacrifice?

    Salary sacrifice (sometimes known as salary exchange) is an agreement between employer and employee, where the employee agrees to a reduction in their salary to for other non-cash benefits from their employers including pension contributions, childcare vouchers, bus passes etc.

    How does salary sacrifice work?

    At its most basic, everyone pays less tax and exchanges this for access to other benefits. As employees’ gross wages are smaller, they pay less income tax and National Insurance (NI), and the employer saves on NI too. Employees may be hesitant to reduce their pre-tax salary, but there are benefits for both employee and employer.

    With Salary Sacrifice, employees and employers can pay tax savings into the employee’s pension pot – helping them increase their retirement savings. Employers could choose to improve (or create) their employee benefits package thanks to these savings.

    As shown in this diagram, both employer and employee pay into their workplace pension pot each month. Reducing the employee’s salary allows the employer contribution to increase. While the minimum an employer must contribute is 3% in the UK, they can choose to contribute more.

    For Employers

    For Employees

    Employee retention

    When employees value benefits their workplace provides, employee retention and workplace wellbeing can improve. This is only possible when employees understand the benefits available, which is where financial education can help.

    Faster growing pensions

    Employees can use salary sacrifice to increase the total contributed to their pension each month. This can lead to a higher retirement income, and a better future quality of life.

    Reduced National Insurance

    As we’ve mentioned, Employers National Insurance contributions can be reduced with Salary Sacrifice. This can allow employers to offer other non-cash benefits such as pension contributions, childcare vouchers, cycle-to-work schemes, technology and company car schemes.

    Access to more benefits

    Workplace schemes can allow employees to access a range of benefits they otherwise would not be able to afford such as Life Assurance or Critical Illness Cover.

    Is salary sacrifice right for employers?

    Every employee between 22 and the State Pension age who earns more than £10,000 each year should be enrolled into a workplace pension scheme. Switching to Salary Sacrifice for all of these employees can be complicated and costly as employment contracts will need to be amended and payroll updated.

    To complicate matters further, employees are able to opt in and out – and this will affect their terms of employment, which must be kept up to date.

     

    Is salary sacrifice right for employees?

    Employees should consider what a reduced gross salary could mean for them. Salary sacrifice can affect the amount of cash they receive each month, how much they can borrow (as credit providers calculate this on salary), and other earning related benefits including their State Pension, Life cover and maternity pay.

    Employees can also decide how much they would like to sacrifice, but this will depend on their employment contract, and their take home salary must not fall below minimum wage.

     

    How salary sacrifice impacts Tax and National Insurance

    Let’s look at an example for an employee. Here, Helen’s total salary before tax is £38,000. She contributes 5% of her salary, and her employer contributes 3%. This table illustrates the increase in her total pension contributions through salary sacrifice.

    Before Salary Sacrifice

    Salary Sacrifice, including Employer NI Rebate

    Difference

    Gross Income

    £38,000.00

    £38,000.00

    N/A

    Net Gross Income

    £38,000.00

    £36,100.00

    -£1,900.00

    Employee Pension Contribution 5%

    £1,900.00

    £1,900.00

    £0.00

    Employer Pension Contribution 3%

    £1,140.00

    £1,402.20

    £262.20

    Total Pension Contribution

    £3,040.00

    £3,302.20

    £262.20

    Taxable Income

    £25,430.00

    £23,530.00

    -£1,900.00

    Income tax

    £5,086.00

    £4,706.00

    -£380.00

    National Insurance

    £2,543.00

    £2,353.00

    -£190.00

    Take Home

    £28,471.00

    £29,041.00

    £570.00

    How much of the Salary Sacrifice changes are added to the employee’s pension, or used to offer other benefits will depend on the terms of the Salary Sacrifice arrangement.

    How can Wren Sterling help me?

    We help our corporate clients manage their workplace pension schemes and communicate the benefits of their scheme to their employees, to maximising their return on investment.

    Talk to an adviser Find out more about Employee Benefits advice

    FAQs

    • Do employees have to opt in to salary sacrifice schemes?

      Do employees have to opt in to salary sacrifice schemes?

      No, and employees can opt out of salary sacrifice at any time. However, if employees are making use of non-cash benefits like the cycle-to-work scheme, they may have to pay off the balance of the agreement, or the value of the bike, depending on the plan details.

    • Do I have to provide salary sacrifice schemes as an employer?

      Do I have to provide salary sacrifice schemes as an employer?

      It is not mandatory for employers to provide Salary exchange (salary sacrifice).

    • Do you pay tax on salary sacrifice?

      Do you pay tax on salary sacrifice?

      Tax does not need to be paid on the salary that is sacrificed.

    • Can I use salary sacrifice if I earn a low salary?

      Can I use salary sacrifice if I earn a low salary?

      Salary sacrifice cannot be used to reduce an employee’s salary to less than minimum wage.

    • When is it not possible to use salary sacrifice?

      When is it not possible to use salary sacrifice?

      Employees can also decide how much they would like to sacrifice, but this will depend on their employment contract, and their take home salary must not fall below minimum wage.

    • Are you automatically enrolled in salary sacrifice schemes?

      Are you automatically enrolled in salary sacrifice schemes?

      Eligible employees must be enrolled in their employer’s workplace pension. It is mandatory for the employer to offer this, but the employee can opt out of a workplace pension. For salary sacrifice, employers need to ask employees if they wish to be part of the sacrifice arrangement. These are two separate arrangements, working together.

    • Can I have a salary sacrifice scheme if I’m self-employed?

      Can I have a salary sacrifice scheme if I’m self-employed?

      Salary sacrifice is not available if you are self-employed unless you are a Company Director of your own limited company and pay yourself dividends. We recommend anyone who is self-employed, who naturally has more complex pension arrangements, to get in touch with us for financial advice.

    • Does salary sacrifice affect your state pension?

      Does salary sacrifice affect your state pension?

      Employees do not pay tax (including National Insurance) on the sacrificed amount.

      Whether an employee will receive a state pension depends on their National Insurance record, so it is possible that this could affect your eligibility.

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