Out-Law Guide 5 min. read
14 Aug 2009, 12:12 pm
This guide is based on UK law. It was last updated in June 2018.
From April 2017 the rules have changed for salary or bonus sacrifice arrangements other than those relating to pension arrangements, pensions advice, employer-supported childcare and cycle-to-work. For arrangements which are not carved out of the new rules, the optional remuneration arrangements (OpRA) legislation now taxes the value of benefits provided, which is deemed to be the higher of the amount of earnings foregone, less any made good by the employee, and the taxable value of the benefit that would otherwise apply. The remainder of this guide considers only salary sacrifices in relation to pension contributions.
What is salary sacrifice?
As the name suggests it involves employees giving up part of their salary, but in return for another benefit.
If the employee sacrificed salary of £5000 in return for a pension contribution by the employer, the employer would pay £5000 into the pension, instead of paying it to the employee and the employee would receive a salary of £5,000 less. However, the employer would save the employer's NIC contributions in respect of the £5000 and income tax would not be deducted under PAYE in respect of the £5000.
Salary sacrifice is also used in respect of other benefits which are not subject to tax, such as childcare vouchers, workplace parking, cycle to work schemes and additional holiday entitlement. It has also been used for a range of other benefits – although new rules mean that salary sacrifice may no longer be tax efficient in relation to other types of benefit.
Benefit of salary sacrifice for employers
The benefit is in the saving the employer achieves in National Insurance Contributions (NICs). The employer pays NICs on the employees' salaries but not on the benefit it is providing as a result of the salary sacrifice, such as pension contributions. The higher the salary, the more the employer has to pay in NICs. Reducing the employees' salaries would therefore allow the employer to pay less in NICs. Collectively, across a large workforce, an employer can achieve a substantial saving in NICs.
Benefit of salary sacrifice for employees
The benefit received as a result of the sacrifice and the reduction in salary should cancel each other out. The advantage beyond that is that the employees should also pay less in NICs. Like the employer, the employees pay NICs on salary, so the lower their salaries the lower their NICs will be. This should produce an overall saving for employees.
Cutting salary can also help employees to put off repaying student loans. It can also enable employees earning just over £50,000 to cut their salaries to less than that amount so they can continue to receive child benefit, which begins to be clawed back if one partner earns more than £50,000.
Will this affect other benefits?
It could do. If salary sacrifice pushes an employee's salary below the Lower Earnings Limit for the purpose of paying NICs then certain state benefits could be affected. These include the basic state pension, statutory sick pay and statutory maternity pay.
Reductions in salary below the Upper Earnings Limit could in some cases also reduce employees' entitlements to the state pension. There might also be an impact on other employment benefits and salary multiples for mortgage purposes, although in practice employers should be able to remove or limit any impact (for example by using a notional 'pre-sacrifice' salary for the purposes of calculating other benefits).
Salary sacrifice could also affect entitlement to working tax credit or child tax credit, and it must not take pay below National Minimum Wage rates. Salary sacrifice is therefore not suitable for all employees, and employers should bear this in mind when deciding whom to include and exclude from salary sacrifice.
Do you need the employees' agreement?
Strictly speaking, yes. Employees will probably have a contractual entitlement to their current salary. If it is reduced as part of salary sacrifice then this amounts to a change in their contractual terms. If this is done without the employees' explicit agreement then this could amount to a breach of contract.
However, employees are unlikely to complain if they gain overall from salary sacrifice. In practice, employers often automatically include employees in salary sacrifice, while at the same time allowing them to opt out if they wish. Most importantly employers should ensure that employees are kept fully informed about all aspects of the salary sacrifice and its impact on employees both before and after implementation.
Note that the interaction of salary sacrifice with pensions auto-enrolment is a complex area, and specific advice should be sought on this point.
Do pension scheme trustees have to agree?
In the case of a salary sacrifice in favour of pension contributions , some amendments may have to be made to the pension scheme's rules in order to implement a salary sacrifice, and so the trustees' agreement may be necessary. However, the trustees should be able to agree on the basis that employees' benefits from the scheme are not affected by salary sacrifice.
What does HMRC have to say about that?
HMRC permits salary sacrifice. The HMRC guidance includes an eight-page guide and a shorter Q&A on how to make salary sacrifice effective.
HMRC insists that salary should be given up completely before it is treated as received for tax and NIC purposes – care is needed if it is proposed that employees will be able to alter their sacrifice more often than the employer's annual benefit selection window. Its guidance also explains in some detail what impact salary sacrifice might have on other benefits. The other point to note is that the salary must be given up before any entitlement to receive it arises - this can be a particular issue in the case of directors as some special rules apply.
Salary sacrifice arrangements do not have to be approved by or notified to HMRC but it is open to employers to consult HMRC on the correct tax treatment of the arrangements.
As mentioned above, the rules have changed for non-pension related benefits.
What about defined contribution and personal pension schemes?
Salary sacrifice can be done in largely the same way as with defined benefit schemes. The employees' salary will be reduced (usually by the amount of the employee's contribution grossed up for the 20% tax relief which the pension scheme would have previously claimed), and the employer will instead contribute this amount to the defined contribution/personal pension scheme.
Can bonus and termination payments be 'sacrificed'?
Yes, bonus and termination payments can be sacrificed in return for a pension contribution from the employer and/or increased pension benefits. Special care must be taken to ensure that these payments are given up before any entitlement to them arises and with the personal tax consequences for the individual employee.
However, any salary sacrifice arrangement must be planned and implemented carefully with full communication, and employers should seek detailed financial and legal advice so that they and their employees are fully aware of the benefits and possible pitfalls in advance.