With National Insurance contributions (NICs) on the rise since April, many employers are scrutinising ways to reduce employment costs. One increasingly popular and effective strategy is salary sacrifice. This arrangement allows both employers and employees to make significant savings on income tax and NICs, while also enhancing employee benefits.
What is Salary Sacrifice?
Simply put, salary sacrifice is an agreement where an employee gives up a portion of their gross (pre-tax) salary in exchange for a non-cash benefit. Because their taxable income is reduced, both parties pay less in tax and NICs. This is particularly appealing for businesses facing higher Class 1 employer NICs, which increased to 15% recently.
Common benefits offered through salary sacrifice include:
Pension contributions: A highly tax-efficient way to save for retirement.
Electric car leasing: Supporting green initiatives and providing a valuable perk.
Cycle to Work schemes: Promoting health and environmental values.
Technology loans: Helping employees acquire IT equipment through affordable payroll deductions.
Childcare vouchers or additional leave.
How it Works: Savings in Action
Let’s look at an example. If an employee sacrifices £1,000 of salary directly into their pension:
Employee savings: They pay no income tax or NICs on that £1,000.
Employer savings: The business saves 15% in employer NICs, which amounts to £150. These savings can then be reinvested or passed back to employees as an extra incentive.
For company directors, especially those taking a mix of salary and dividends, pension salary sacrifice is often one of the most efficient ways to extract profits while planning for the future. Even if you’re on a relatively low salary to minimise NICs, the sacrificed portion isn’t subject to income tax or NICs for either party, and the company also benefits from corporation tax relief on the pension contribution.
Director Example:
If a director earning £60,000 sacrifices £6,000 per year into a pension:
Employee saves £1,200 in income tax and £120 in NICs (total £1,320).
Employer saves £900 (15% NIC on £6,000).
The full £6,000 goes into the pension gross.
Employee Example:
An employee on a £35,000 gross salary wants to put £2,000 into their pension.
Without salary sacrifice: They pay tax and NICs on the £35,000, then contribute from their net pay, potentially missing out on some tax relief.
With salary sacrifice: Their gross salary becomes £33,000, and the employer pays £2,000 directly into their pension. The employee saves £400 (20% income tax on £2,000) and £160 (8% NICs on £2,000), a total saving of £560. The employer also saves £300 (15% NIC on £2,000).
Benefits and Pitfalls to Consider
For Employers:
Pros: Reduces overall employment tax, boosts pension savings, enhances staff attraction and retention, and aligns with environmental/social values.
Cons: Requires careful compliance with National Minimum Wage rules and clear communication of scheme terms. Regular monitoring is essential.
For Employees:
Pros: Significant tax and NICs savings, boosts valuable benefits like pensions, and can improve overall financial wellbeing.
Cons: Reduces gross salary, which can impact mortgage applications, statutory pay (like maternity pay), bonuses, or overtime, as these are often based on actual salary.
Strategic Workforce Planning
Salary sacrifice schemes are no longer just a tax perk; they’re a strategic tool for smarter workforce planning. With rising employment costs and increasing demand for flexible benefits, they allow employees to boost their benefits and reduce tax liability, while offering employers considerable savings.
However, individual circumstances vary. Both employers and employees need to carefully consider if salary sacrifice is the right fit for them.
Is salary sacrifice right for your business? At Max Pro Accountants, we can help you assess the potential savings and navigate the complexities of these arrangements. Contact us HERE today for tailored advice.