What is Salary Sacrifice?

A salary sacrifice arrangement is an agreement between an employee and their employer which allows the employee to give up part of their salary in exchange for a non-cash benefit.

This blog considers two of the most tax-efficient salary sacrifice schemes that are currently available.

Pension Salary Sacrifice

Salary sacrifice can be a very tax-efficient way to make pension contributions

A common arrangement is for an employee to pay their pension contributions out of their net salary.  These contributions are deemed to be paid net of 20% basic rate tax relief, broadly meaning that if an individual pays £80 into their pension, the Government will top this up by £20 to give a total contribution of £100.  There are two better options available:

1. A salary exchange agreement with all savings retained by the employee and employer; or
2. A salary exchange agreement whereby all employee and employer savings are used to increase the overall pension contribution.

These options are discussed in further detail below:

Simple salary exchange agreement

This arrangement involves deducting the equivalent gross pension contribution from an employee’s salary before PAYE and National Insurance is deducted.  The net tax position and the amount paid into the pension fund remains the same, but both Primary and Secondary National Insurance Contributions are reduced.

Let’s take the example of a UK taxpayer with a salary of £40,000 in the 2023/24 tax year, who currently pays a net contribution of 4% (gross equivalent 5%) of their salary into pension.  The potential savings available by switching this to a salary exchange arrangement is demonstrated below:

Existing arrangement			Salary exchange alternative
Salary	£40,000	Salary		£40,000
Less salary exchange pension	n/a	Less salary exchange pension (5%)		£2,000
Income after pension relief (A)	£40,000	Income after pension relief (A)		£38,000
Less personal allowance	£12,570	Less personal allowance		£12,570
Income subject to tax and NIC	£27,430	Income subject to tax and NIC		£25,430
Tax thereon		Tax thereon
£27,430 @ 20% (B)	£5,486	£25,430 @ 20% (B)		£5,086
National Insurance		National Insurance
£27,430 @ 12% (C)	£3,292	£25,430 @ 12% (C)		£3,052
Personal pension contribution		Personal pension contribution
4% x £40,000 (D)	£1,600	Not applicable (D)		nil
Net take home pay (A-B-C-D)	£29,622	Net take home pay (A-B-C-D)		£29,862

In the above example the employee saves £200 of National Insurance contributions each year.  In addition, the employer will save National Insurance of £276 (£2,000 x £13.8%).  Therefore, in total the salary exchange arrangement will save £476 each year.

Salary exchange with all savings paid into pension

This option works by effectively passing all employer and employee savings into pension.  The objective here is to leave both the employer and employee in the same net position as they would be without a salary sacrifice arrangement in place.

This calculation is far more complex, but if this method was adopted the amount paid into the employee’s pension would increase from £2,000 to nearly £2.700.  This represents an effective increase in the employee’s pension contributions from 5% of gross salary to over 6.5% without reducing net take home pay.

Salary Sacrifice for Electric Cars

It is becoming increasingly popular for salary sacrifice to be used as a method for leasing electric cars.  However, for this type of tax planning to be effective, the arrangement must be for the lease of a fully electric vehicle.  There is no tax saving available if the salary sacrifice arrangement is for the lease of a petrol, diesel, or hybrid car.

Under this scheme, an employer takes out a lease on an electric vehicle which is then provided to the employee as a company car.  The employee then takes on the monthly lease payments via salary sacrifice, saving income tax and NIC.

As with a normal company car, the employee is taxed on the value of the benefit in kind.  From 6 April 2023 the benefit in kind for a fully electric vehicle is only 2% of the list price.  A £50,000 car would therefore generate a taxable benefit of only £1,000, resulting tax charge of around £400 for a higher rate taxpayer in the UK or £420 in Scotland.

Take the example of a UK higher rate taxpayer who leases a Tesla Model Y with a list price of £58,500 over a term of 36 months.  Their annual salary will be reduced by leasing charges of around £11,500.  This in turn will reduce their income tax by £4,600 and their NICs by £230 for the year.  The tax on the benefit in kind will be £468, giving a total saving for the year of £4,362.  The net cost of the car is therefore £7,138 per annum.

Typically, the lease payments will include:

• Full insurance cover
• Accident management
• All servicing, maintenance, and tyres included in the contract
• Roadside assistance.

Furthermore, if the employer pays for a vehicle charging point to be installed at an employee’s home, no taxable benefit arises.

The employee may be expected to pay to charge the car, but if the employer provides a charging point at the workplace no tax charge applies.  However, if the employer pays an employee to charge their car from another location this would be subject to tax, albeit the employee would be able to claim a mileage allowance for business journeys in the normal fashion.

A Word of Caution

Salary sacrifice may be of particular interest to high earners, particularly those earning more than £100,000 as in some cases it may help to reinstate lost personal allowances.

However, for lower earners it is important that they consider their personal circumstances before opting into a salary sacrifice arrangement.  This is because a reduced salary may affect the following:

• Their entitlement to certain state benefits, such as statutory sick pay, maternity pay, and tax credits
• Their entitlement to death in service benefits provided by their employer
• The amount that some mortgage lenders will allow the employee to borrow, depending on their lending criteria

Finally, it is important that any salary sacrifice arrangement does not result in an employee’s gross earnings falling under the National Minimum Wage limit.

If you would like to discuss how salary sacrifice arrangements could benefit your business please get in touch.

The information in this blog provides only an overview of HMRC guidance and legislation in force at the date of publication and no action should be taken without consulting the detailed HMRC guidance and legislation or seeking professional advice.  Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this blog can be accepted by the firm.