What is a salary sacrifice scheme?

Salary sacrifice is when you agree to exchange part of your salary so you can get extra benefits from your employer. Benefits offered can include child care vouchers, a company car and additional pension contributions. But is it worth doing? Read on for the pros and cons of salary sacrifice.

How salary sacrifice works

Does your employer run a salary sacrifice scheme? If so, signing up could leave you better off when it comes to childcare costs and your final pension.

Many organisations now offer salary sacrifice schemes.

The idea behind this is quite simple. You give up part of your salary and, in return, your employer gives you a non-cash benefit, such as childcare vouchers, or increased pension contributions.

Once you accept a salary sacrifice, your overall pay is lower, so you pay less tax and National Insurance.

In addition, your employer will not have to pay their Employers’ National Insurance contributions on the part you sacrifice.

Some employers pass on some or all of these savings to you.

Things to consider before taking a salary sacrifice

  • Sacrificing part of your salary means you earn less. This might affect maternity pay or mortgage applications.
  • Lower earnings might also affect your State Pension or contribution-based state benefits. These might include Jobseeker’s Allowance and Employment and Support Allowance. However, you might be able to claim more tax credits.
  • A lower salary, as a result of salary sacrifice, means any life cover through a scheme at work could be less. It’s worth checking – some employers do provide life cover at your original salary so you don’t lose out.

Examples of salary sacrifice benefits

Salary sacrifice schemes only work for you and your employer if the benefits involved are tax-free.

These can include:

  • Company cars
  • Childcare vouchers
  • Work-related training
  • Cycle to work schemes
  • Car parking near your workplace
  • Additional employer pension contributions

Salary sacrifice for childcare vouchers

You agree to sacrifice part of your salary and your employer gives you tax-free vouchers that you can use to pay for childcare.

You can still choose your own childcare provider or nursery but they must be state registered or Ofsted approved.

There are limits to how much you can claim in tax-free vouchers, depending on the rate of tax you pay.

Level of tax you pay Tax-free voucher limit
Basic-rate tax £243 a month
Higher-rate tax £124 a month (if you have joined the scheme on or after 6 April 2011). If you joined before then, you can have up to £243 a month.
Additional-rate tax £110 a month (if you have joined the scheme on or after 6 April 2011). If you joined before then, you can have up to £243 a month.

If your employer offers any extra childcare vouchers, then you will pay tax on them.

How salary sacrifice affects tax credits

To work out what’s best for you, use the HM Revenue & Customs calculator.

Accepting childcare vouchers from your employer might affect your tax credits.

If you’re already getting tax credits to help with childcare costs, you’re probably better off not opting for salary sacrifice.

That’s because you can only claim tax credits for the childcare you pay with your own money, rather than with vouchers.

Example

If you have £2,000 a month gross pay, you would take home £1,571 after tax and National Insurance.

Sacrificing £243 a month of gross pay for the same value in childcare vouchers would reduce your take-home pay to £1,406.

But with the childcare vouchers, you would now have £1,406 + £243 = £1,649 in total.

You would be £78 better off because of the tax and National Insurance you’ve saved.

New childcare scheme

From September 2017, working parents of three and four-year-olds will be able to get 30 hours’ free childcare a week, worth around £5,000 a year per child.

The existing Childcare scheme will run until the new scheme, Tax-Free Childcare, is launched in early 2017. (It will be available in some local areas from September 2016).

It’s going to be available to families of under 12s where both parents are working (and working single parents) who are not already claiming tax credits.

When it starts, you’ll get 20% of your yearly childcare bill paid for by government.

How it works:

  • You open an online account through GOV.UK and pay into it to cover your childcare costs.
  • The government tops up your account with a 20% contribution (the same as the basic rate of tax), up to a maximum contribution of £2,000 a year per child.
Find out more about Tax-Free Childcare on the GOV.UK websiteopens in new window.

Changes to employee benefits from April 2017

The government has announced that the tax PAYE (income tax) advantages of some employee benefit arrangements offered through salary sacrifice schemes will end for anyone newly joining a scheme in April 2017. There will be some protection for staff joining these schemes before the April deadline (see below).

After this date, you will have to pay PAYE on these benefits if you take them up as part of an employment package.

You will continue to receive National Insurance savings and should still retain existing savings enjoyed from being a member of a Salary Sacrifice.

For example, this might include a reduction in a work-based pensions contribution, or Trade Union contributions, where these are based upon a percentage of your gross earnings.

Exempt schemes

Some benefits will continue to be offered PAYE and NI-free through salary sacrifice schemes after April 2017.

These include:

  • Childcare
  • Cycle to Work schemes.
  • Ultra-low emission cars.
  • Pensions (Including advice).

Protection

Employees enrolled in a car, accommodation or school fee salary sacrifice agreement, before 6 April 2017, will be protected until the end date of their agreement, or until 5 April 2021, whichever is sooner.

For all other schemes the protection runs until the end date of the agreement, or until 5 April 2018, whichever is sooner.

Please note: As there are so many salary sacrifice schemes and different terms and conditions, we advise you check with your employer’s benefits or human resources team (or dedicated intranet websites, if available) whether there are any additional benefits and risks associated with belonging to these schemes.

Did you find this guide helpful?