How does salary sacrifice work?
Many employers offer salary sacrifice schemes, giving staff an opportunity to exchange part of their salary for a non-cash benefit such as childcare vouchers, a bike or company car. It can also be referred to as ‘salary exchange’ and one of its most common uses is increasing pension contributions.
A salary sacrifice pension allows you to use the money you save on National Insurance Contributions and income tax to top up your pension and increase its value over time. Because of the savings you can make, pension contributions made in this way are more tax efficient than the personal contributions you’d ordinarily pay into your pension. With this system, you can make the same amount of contributions for a lower overall cost, or a higher level of contributions for the same overall cost.
Not all employees will qualify for salary sacrifice and if you’re on a low wage it may not be possible to reduce your earnings further. Your earnings will need to be more than the national minimum wage after taking advantage of this type of contribution.
It can be setup through a contractual agreement with your employer, however you should be able to opt out of the scheme at any time, as long as outstanding balances have been paid. Salary sacrifice comes at no additional cost to you or your employer and there are several tax benefits for both parties.
Salary sacrifice and tax
When you give up part of your wages through a salary sacrifice scheme, you’ll pay less tax and national insurance on your gross earnings. Your employer will also save money as they won’t have to pay Employers’ National Insurance Contributions on the part of your wages that you sacrifice and may pass some or all of these savings on to you.
Salary sacrifice pension tax relief
Usually the personal contributions you make to your pension are eligible for tax relief from the government. The standard amount of tax relief is a 25% tax top up for basic rate taxpayers, meaning that if you put £100 into your pension pot, HMRC effectively adds another £25. When you make personal contributions to your PensionBee pension, PensionBee will claim your tax top up for you and add it to your pension pot automatically. If you are a higher-rate tax payer, you will need to claim any additional tax relief yourself through your self-assessment tax return.
Any contributions you make through salary sacrifice are exempt from tax relief as you’ll have already benefited from reduced tax on your lower salary. For this reason you won’t need to complete a salary sacrifice tax return and cannot claim tax relief.
Things to consider before taking a salary sacrifice
While there are several benefits to joining a salary sacrifice scheme, there are also some considerations. If you agree to take a lower salary, the level of benefits you receive from your employer may also decrease. For example, if you qualify for sick pay or holiday pay the amount you receive will be less, and if you plan to take an extended period of leave, or claim maternity or paternity leave, you might not earn as much as you need.
If you opt to sacrifice your salary and receive a lower income for an extended period of time, you could affect your ability to claim the State Pension in the future. To qualify for the new State Pension you’ll need to have paid National Insurance Contributions (or received eligible credits), for at least 10 years. To receive the full State Pension you’ll need to have paid National Insurance Contributions for at least 35 years.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
Last edited: 21-03-2022