Salary sacrifice

What is salary sacrifice?

Giving up part of your pay every month might sound like a strange idea, but it can make financial sense.

Salary sacrifice enables you to exchange part of your salary for a non-cash benefit from your employer, such as increased pension contributions.

Salary sacrifice is commonly used to boost your pension, but you can also give up salary in return for benefits such as bikes, mobile phones and bus passes.

Salary sacrifice options vary, as employers must choose to opt into a scheme. Check with your employer to see whether any salary sacrifice schemes are on offer.

How do salary sacrifice schemes work?

You'll sign a salary sacrifice contract with your employer, where you agree to forgo a certain amount of pay in return for certain benefit.

The amount can vary depending on what the salary sacrifice is for, and what terms your employer has in place.

You can usually change the amount of money you sacrifice, but this has to be agreed with your employer.

You can opt out of salary sacrifice at any time. But if you were using it to finance something you own - for example, a bike or mobile phone - you will still need to pay off the outstanding amount.

Do I pay less tax with salary sacrifice?

Under the following salary sacrifice schemes, the salary you forgo will not be subject to income tax or National Insurance contributions:

• bicycles and cycling safety equipment
• payment into pension schemes
• workplace nurseries
• employer-provided pensions advice
• employer-provided childcare that started on or before 4 October 2018.

By essentially giving up a portion of your salary, the amount you get paid is therefore reduced. This, in turn, reduces the amount of income tax and National Insurance you pay, and the National Insurance contributions your employer makes will be reduced, too.

This means that more of your money is being spent on things that benefit you - like your pension - and less taken through tax.

However, since April 2017, employees have been required to pay tax and National Insurance on salary they give up under any other salary sacrifice schemes or flexible benefit schemes.

If the benefits you receive are taxable - such as private health insurance - they may be recorded on your P11D form. This is submitted to HMRC by your employer each tax year. You should receive a copy of this by 6 July each year.

While you may not save on tax under these other schemes, you're likely to benefit from cheaper corporate rates. You can also buy high-value items outright that you might not otherwise be able to afford.

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Increasing your pension with salary sacrifice

You can reduce your income tax and National Insurance (NI) contributions by giving up part of your salary and directing it to your pension instead.

The employer would save on NI contributions and might be persuaded to add this saving to the pension contribution, boosting the amount paid towards your pension even more.

To see how much you might stand to benefit, let's take a closer look at the impact of salary sacrifice on pension contributions for someone earning £25,000 during 2024-25 - where employees pay 5%, and employers pay 3% of the salary into a personal pension scheme. This reflects the current auto-enrolment contributions.

The comparison below assumes that the personal allowance has already been used, and looks at what income tax you'd pay with and without salary sacrifice:

Without salary sacrifice

1. Your total salary remains unchanged at £25,000.
2. The basic rate of income tax is 20% - so that leaves you with £20,000.
3. You then pay 5% (£1,000) of your salary into a private pension. That reduces your annual earnings to £19,000.
4. However, you receive tax relief of 20% on 5% of your pay before tax, so that's an extra £250 added to your own contribution. There's now a total of £1,250 in pension contributions.
5. Finally your employer puts in 3%, leaving you with a total of £2,000 in pension contributions.

With salary sacrifice

1. First, the employer cuts your pre-tax salary by £1,000, bringing the total to £24,000.
2. Once you have taken away the basic rate of income tax (20%), you're left with £19,200.
3. The employee then puts in 5% of their remaining salary into pension contributions - in this case £960.
4. Because there's 20% tax relief on the 5% pension contribution, you can add £240 to the total pension contributions. That brings the total pension contributions to £1,200.
5. Now let's add the 3% employer contribution plus the £1,000 salary sacrifice. That brings the overall total pension contributions to £2,920.

While the thought of giving up £1,000 may sound like a lot of money, over the course of a year you'll be losing less than £70 a month (as a basic-rate payer) - it could make a significant difference to your pension pot when you come to retire.

Please note that the example above only shows the effects of income tax - National Insurance contributions will also be a factor.

Childcare vouchers and salary sacrifice

Some employers allow parents to exchange part of their salary for tax-free childcare vouchers - this scheme closed to new applicants in October 2018, but existing claimants can continue to use the service for as long as their employer offers it, or until they change jobs.

If you fall under the scheme, you can choose your own childcare or nursery, but they must be state registered or Ofsted approved. You pass on the vouchers to your childcare provider.

As an alternative to childcare vouchers, the government has introduced tax-free childcare.

You can find out more about how these schemes compare in our guide: tax-free childcare and other ways to save

Salary sacrifice and bikes

Many employers allow their employees to use Cycle To Work schemes to save money on the purchase of a bicycle.

You start by choosing the bike you want. The bike is bought by your employer, who then leases it to you. Many employers can reclaim the VAT and have the option of passing this saving on to you.

Your salary will be reduced by the net cost of the bike for the hire period.

Once the hire period ends, you can buy the bike from your employer at a 'fair market value' set by HMRC.

After one year, this is 25% of the bike's original value for bikes costing more than £500, or 18% of the bike's original value for bikes that cost less than £500.

If your hire period is longer than a year, you can buy the bike for less.

This scheme also allows you to avoid tax and National Insurance on the part of your salary you sacrifice, resulting in significant savings.

What are flexible benefit packages?

Some employers offer flexible benefit packages, which allow employees to buy extra or different benefits from the ones the employer offers as standard.

For example, you might choose to buy additional life insurance or critical-illness cover, or to extend benefits such as private health insurance or health screening to your partner. You can also choose to 'buy' additional holiday, or, if you prefer, give up holiday in return for extra cash.

These schemes are sometimes known as 'cafeteria benefits' or 'flex plans', as they allow employees to vary their pay and benefits package in order to suit their own personal requirements.

You may be able to get benefits such as extra life insurance or critical-illness cover more cheaply by buying through your employer, as your employer is able to buy in bulk.

Intangible benefits - including annual leave - can be purchased without needing to pay tax or National Insurance on that portion of your salary.

What are the downsides to salary sacrifice?

While the salary you've sacrificed is being spent on something of your choice, you'll never actually see the money in your bank account each month.

A lower salary can affect entitlements like maternity/paternity pay, mortgage applications based on your income and some state allowances. However, it may mean you're able to claim more tax credits.

You should also check with your employer to make sure your bonuses, pay increases and pension benefits won't be affected.

Salary sacrifice is unlikely to work for those on low incomes, as your take home salary is not allowed to fall below the national minimum wage.

Salary sacrifice: your questions answered