Salary sacrifice lets an employee give up part of their gross pay in return for a benefit like extra pension, an electric car or a cycle-to-work bike, and because the sacrifice comes out before tax and National Insurance it can save both you and them money. Done properly it is a genuine win. Done carelessly it breaches the minimum wage, upsets statutory pay, or falls over because the contracts were never varied. We set salary sacrifice up correctly, apply the right National Insurance treatment, watch the pitfalls, and run it through your payroll each period. This page explains how it works and how we handle it.
What salary sacrifice is
Salary sacrifice is an arrangement in which an employee agrees to give up part of theirgross salary in exchange for a non-cash benefit of equivalent value. Instead of receiving that slice of pay as cash and then buying the benefit out of taxed income, the employee never receives it as cash at all: their contractual salary is reduced, and the employer provides the benefit directly.
The reason it is worth doing is where the money is taken from. The sacrificed amount comes outbefore income tax and National Insurance, so it is not treated as earnings in the normal way. For the right kind of benefit, that produces a real saving for both the employee and the employer, because neither pays National Insurance on the sacrificed portion. It is a legitimate, long-standing arrangement, but it is one HMRC has specific rules about, and it only works when it is set up correctly. That is the difference between a scheme that saves money cleanly and one that creates a problem.
Common salary sacrifice schemes
Salary sacrifice can in principle apply to many benefits, but a few schemes are by far the most common, partly because they keep their full tax and National Insurance advantages:
- Pension contributions. By far the most popular. The employee sacrifices salary and the employer pays the equivalent, plus often the National Insurance saved, into their workplace pension. It boosts retirement saving efficiently and works neatly with auto-enrolment.
- Electric cars. Sacrificing salary for the use of an electric company car remains highly tax-efficient because of the low benefit-in-kind rates on electric vehicles, making it one of the fastest-growing schemes.
- Cycle to work. The long-established scheme that lets employees get a bike and equipment through salary sacrifice, encouraging greener commuting.
Some other benefits can be offered through salary sacrifice too, but many of them have had their tax advantages removed, so the saving is smaller or gone. Pension, ultra-low-emission cars and cycle to work are the schemes where the arrangement still does real work, and they are the ones we most often set up for clients. Because pension is so central, salary sacrifice sits closely alongside our auto-enrolment and pensions service.
Explore each scheme in detail
Each scheme works a little differently, and the questions employers ask us change with it. The pages below go deeper on how each one is taxed, set up and run, and there is a calculator to estimate the saving on a given sacrifice.
National Insurance savings for both sides
The headline benefit of salary sacrifice is the National Insurance saving, and it works for both the employer and the employee. When salary is sacrificed, that portion is no longer paid as cash earnings, so it no longer attracts employee National Insurance oremployer National Insurance. The employee also saves income tax on the sacrificed amount, because it is provided as a benefit rather than taxed pay, and for pension in particular the benefit itself is tax-advantaged.
The employer saving is often overlooked but can be significant across a workforce, because the employer's National Insurance on the sacrificed pay simply disappears. Many employers choose to pass some or all of that saving back to employees, most commonly by adding it to their pension contribution, which makes the scheme more attractive and improves staff retirement outcomes at little or no extra cost to the business. We calculate the saving correctly and set the scheme up so the National Insurance treatment is right for both sides.
The effect on pay, pension and statutory pay
The one thing to understand before entering salary sacrifice is that it genuinelyreduces gross pay. That is the whole mechanism, and it has knock-on effects that have to be thought through, because a range of other figures are calculated from gross pay:
- Statutory payments. Statutory maternity, paternity and sick pay are based on average earnings, so a salary sacrifice in the relevant period can reduce what an employee is entitled to. This matters most for anyone who may soon take family leave.
- Pension basis. Depending on how the scheme and the pension are set up, sacrifice can change the earnings figure that pension contributions are worked out from, which needs to be handled so contributions stay correct.
- Borrowing and benefits. A lower gross salary can affect mortgage affordability assessments and some earnings-related entitlements, so employees should understand the trade-off.
None of these makes salary sacrifice a bad idea, but they make it something to set up with care rather than switch on blindly. We work the effects through for your specific staff before anything starts, so the arrangement helps rather than quietly costs someone at the wrong moment.
The contract variations you need
A valid salary sacrifice is not a payroll deduction. It is a genuine change to the employee's contractual pay, and HMRC will only accept it as effective if it is documented as such. That means the employee's terms have to be varied, in writing, and the variation has to be in placebefore the sacrifice begins. You cannot backdate a sacrifice, and you cannot simply start taking an amount off the payslip and call it salary sacrifice.
Getting this wrong is one of the most common reasons a scheme fails a review: the payroll shows a sacrifice, but there is no proper contractual basis for it, so the tax and National Insurance treatment is not actually valid. We make sure the arrangement is set up on the right footing, with the variation agreed before we run it, so the saving stands up. Where legal wording of contracts is involved, we work alongside your own advisers so the paperwork and the payroll match.
Pitfalls to watch for
Salary sacrifice is safe and worthwhile when it is run properly, and the pitfalls are all avoidable once you know them:
- The National Minimum Wage floor. This is the big one. Salary sacrifice cannot take an employee's cash pay below the National Minimum Wage or National Living Wage, because those are measured on the reduced, post-sacrifice pay. For lower-paid staff, a sacrifice may simply not be possible, and it has to be checked every pay run as hours and rates change.
- Statutory pay reductions. As above, sacrificing in a qualifying period can cut maternity or sick pay entitlements, which can be an unwelcome surprise for the employee.
- Missing contract variations. Without a proper, prior variation of terms, the arrangement is not a valid sacrifice and the tax treatment can be challenged.
- Reportable benefits. Some sacrifice benefits, such as a car, still create a reportable benefit in kind or Class 1A National Insurance that has to be handled correctly.
- Life events and opting out. Employees may need to change or leave a sacrifice on a genuine lifestyle change, and the scheme has to allow for that.
We watch every one of these on your behalf, and the minimum wage floor in particular is checked on each run, so a scheme that saves money never quietly tips someone below the legal minimum.
How we set it up and run it
Salary sacrifice rewards being set up carefully and run consistently, which is exactly what a payroll bureau is for. We start by checking that the scheme you want stacks up for your staff, flagging anyone the minimum wage floor rules out and working through the effect on pensions and statutory pay. We make sure the contractual variations are in place, then build the sacrifice into your payroll so the reduced salary, the benefit and the correct National Insurance treatment are all applied accurately, with a payslip your staff can understand.
Each pay period we process the arrangement as part of your normal payroll, keep the minimum wage check running, handle any reportable benefit or Class 1A National Insurance a scheme creates, and keep the pension and statutory-pay effects correct. If someone needs to change or leave their sacrifice, we handle that too. It sits inside your wider payroll rather than being a separate thing you have to manage.
We are a South Wales payroll bureau with more than 60 years of combined experience, and many of our clients have been with us since 2006. We are CIPP members and Chartered Accountants (ICAEW), and we are ICO registered and Cyber Essentials certified, so your salary sacrifice and your employees' data are in careful, accredited hands. If you want salary sacrifice set up and run correctly through payroll, talk to us about your payroll or see how our pricing works.