The system of a salary sacrifice is where an employee reduces their pay to receive a non-cash benefit. Employers set up such arrangements by changing the terms of the employee’s contract to reflect what is agreed. But there are some rules which mean that they cannot earn less than the national minimum wage.
What is a salary sacrifice?
Lots of employers are now offering a salary sacrifice scheme, where employees are giving up part of their salary for a range of benefits including childcare vouchers or an increased contribution to their pension. When a staff member takes this, they also pay less tax and National Insurance as their wage is lower and employers don’t need to pay NI for the portion of salary that is sacrificed.
Some of the examples of things that employees have sacrificed salary for include:
• Company cars
• Childcare vouchers
• Cycle to work schemes
• Parking place near to work
• Work-related training
An example in action
Here’s an example of how salary sacrifice might work. If the employee chooses to sacrifice some salary to get childcare vouchers, they must use a state registered or Ofsted approved provider and there are limits based on how much they earn:
• Basic rate – £243 a month
• Higher rate – £124 a month if joined before 6th April 2011 or £243 if joined after wards
• Additional rate tax – £110 a month if joined before 6th April 2011 or £243 if joined after wards
If you agree to provide more than this to an employee, then they will need to pay tax on the extra amount.
Working out the national insurance and tax
If you use a outsourced payroll service, you don’t need to worry too much about the technicalities of this, but it is worth understanding the basics. As a business, you need to pay and deduct the right tax and NI from cash and benefits provided.
For non-cash benefits, you need to find the value of the benefit. You should choose the higher or either:
• The amount of salary sacrificed
• Earnings charge under the ‘normal benefit in kind’ rules
Non-cash benefits are also reported differently from normal earnings. Generally, benefits are reported to HMRC at the end of that tax year using the end of year expenses and benefits form, which is found online. You can also contact the HMRC Clearances Team to get to them to confirm the tax and NI implications of the salary sacrifice.
Changing terms of the arrangement
If an employee already has a scheme in place and wants to change it or opt out of it and restore their wage, you must remember to alter their contract accordingly. It should always show that cash and non-cash entitlements are included at that point.
It might also be required to change the scheme if there is a change in the employee’s lifestyle such as getting married or divorced. Arrangements can allow opting in or out when these changes happen. If employees can swap whenever they like between cash and non-cash benefits, then the tax and national insurance advantages normally won’t be applied.