Salary Sacrifice – how to avoid the pitfalls

Salary sacrifice, an arrangement between employers and employees, offers enticing benefits like increased take-home pay and tax savings. However, navigating its complexities requires vigilance to avoid potential pitfalls. Below, we delve into the advantages of salary sacrifice, from enhanced employee perks to reduced employer National Insurance Contributions. But we also uncover common pitfalls and provide strategies to avoid them, remaining compliant. Find out more below.

What is salary sacrifice?

Salary sacrifice is a contractual arrangement between employers and employees. It involves employees opting for a reduced cash salary in exchange for non-cash benefits like cycle to work company cars, or increased employer pension contributions. This approach has gained traction over time due to tax and NI savings. Employees gain access to non-cash perks, while employers benefit from decreased employer National Insurance Contributions owing to the reduced gross pay.

How does salary sacrifice work?

With a £50,000 gross salary, the employee allocates 5% to a workplace pension, while the employer contributes 3% under auto-enrolment regulations. The table illustrates how a decrease in gross pay can lead to a rise in take-home pay.

ExampleBefore Salary SacrificeAfter Salary Sacrifice
Employee pension contribution£2,500£0
Employer pension contribution£1,500£4,000
Employee national insurance contribution£2,993.88£2,793.96
Employer national insurance contribution£5,644.80£5,299.68
Total PAYE tax£7,484£6,984
Net pay£37,522.12£37,722.04
The above figures are based on 2024/25 rates

How can you avoid the pitfalls that come with salary sacrifice?

Navigating salary sacrifice requires careful consideration to avoid potential pitfalls. From unintended tax consequences to regulatory compliance issues, there are several factors to keep in mind. Let’s explore some key strategies to sidestep common pitfalls and maximise the benefits of salary sacrifice. 

Employee education

By providing clear and comprehensive information about the implications, benefits, and risks of salary sacrifice arrangements, you can empower your employees to make informed decisions. This includes explaining any potential changes to take-home pay, tax implications, and long-term effects on pension contributions. 

Additionally, offering training sessions or informational resources can enable your employees to understand the value of non-cash benefits. By providing transparency and communication, you can ensure that your employees are equipped to navigate salary sacrifice effectively and maximise its advantages while minimising potential drawbacks.

Legal compliance

Legal compliance is paramount in navigating salary sacrifice effectively. Employers must ensure that salary sacrifice arrangements adhere to relevant tax regulations, employment laws, and pension regulations. 

This includes accurately calculating tax implications, complying with auto-enrolment requirements, and respecting employee rights such as ensuring payment of the National Minimum Wage (NMW). Frequent checks and necessary updates to salary sacrifice policies to reflect changes in legislation or guidance is essential. 

By prioritising legal compliance and seeking expert advice when necessary, employers can minimise the risk of penalties, disputes, and reputational damage associated with non-compliance, ensuring a smooth and lawful implementation of salary sacrifice schemes.

Review regularly

Regularly reviewing salary sacrifice policies with your employees is a crucial factor in avoiding any issues that may arise. Employers should consistently re-evaluate and update their policies to ensure they align with evolving tax laws, employment regulations, and industry standards as a minimum, reviewing rates of pay in line with the NMW. This proactive approach helps identify and rectify any potential compliance issues, ensuring the arrangements remain effective and legally sound. 

Regular reviews also provide an opportunity to assess the programme’s impact on employee satisfaction and make any necessary adjustments. 

By staying up to date and responsive to changes, employers not only maintain legal compliance but also optimise the benefits of salary sacrifice arrangements.

Employer awareness of hidden costs associated with salary sacrifice

When an employee goes on family leave and is in receipt of statutory payments, the payments are protected throughout the whole duration of the leave. Therefore the employer must cover salary sacrifice, which potentially means an increased cost to the business. Good policies need to be in place to avoid employees increasing salary sacrifice amounts just before they go on leave.

Is salary sacrifice taxed?

Salary sacrifice itself is not taxed, but the benefits received through salary sacrifice arrangements may be subject to taxation. When an employee chooses to sacrifice a portion of their salary in exchange for non-cash benefits, the sacrificed amount is deducted from their gross salary before tax is calculated. This can result in a lower taxable income for the employee, potentially reducing the amount of income tax they pay. 

However, it’s important to note that some benefits in kind received through salary sacrifice may still be subject to other taxes, such as National Insurance Contributions (NICs) or Value Added Tax (VAT), depending on the nature of the benefit and applicable regulations.

Can employees opt out of salary sacrifice?

Yes, employees generally have the right to opt out of salary sacrifice arrangements usually if there is a life style change which significantly impacts on the employee’s financial position. If an employee swaps between cash and non-cash earning whenever they like, any tax and NI saving advantages under the salary sacrifice arrangement will not apply.

However, employers must adhere to certain regulations when implementing and managing salary sacrifice schemes. Employees should be provided with clear information about the terms and implications of salary sacrifice, including their right to opt out if they choose. 

Additionally, employers must ensure that any opt out requests are processed promptly and accurately and that employees are not disadvantaged or penalised. 

It’s important for employers to communicate openly with employees about their options regarding salary sacrifice and to respect their decisions in this regard.

Is salary sacrifice suitable for everyone?

While salary sacrifice can offer various benefits for both employers and employees, it may not be suitable for everyone. Employees considering salary sacrifice should evaluate their individual financial circumstances, including their overall income, expenses, and long-term financial goals. Additionally, those with existing financial commitments or specific tax considerations may find that salary sacrifice arrangements do not align with their needs or preferences.

Similarly, employers should carefully assess the potential impact of salary sacrifice on their workforce and business operations. Factors such as workforce demographics, employee preferences, and administrative capabilities should be taken into account when implementing salary sacrifice schemes.

Ultimately, the suitability of salary sacrifice will depend on individual circumstances and objectives. Employers and employees should consider seeking professional advice from financial advisors to determine whether salary sacrifice is the right choice for them.

Get in Touch

Our expert payroll services team offers tailored solutions to seamlessly integrate salary sacrifice into your payroll. If you have any other questions relating to salary sacrifice and non-cash benefits please speak to our payroll experts.

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