What exactly is salary sacrifice?

Salary sacrifice is an agreement between an employer and employee where the employee gives up part of their gross salary in exchange for a non-cash benefit. The objective of this is to reduce taxable income which means that the employee pays less in income tax and both parties pay less in national insurance contributions. After the recent employer national insurance hikes, which took effect in April 2025, now is the right time to review payroll to minimise costs and maximise tax efficiency. Following these NI changes, many employers are now facing higher employment costs across the board because Class 1 employer NICs have been increased by 1.5% to 15% and at the same time the thresholds have been cut. An option to consider to reduce the overall effect of these changes is salary sacrifice, which offers both tax benefits and enhanced employee rewards.

Salary sacrifice benefits when foregoing direct income include things like additional pension contributions, car leasing, the cycle to work scheme and technology loans. The latter is not as well-known as the others and is where an employer lends an employee money to purchase personal IT equipment like laptops, spreading the costs through payroll deductions. Other more unusual benefits include offering the option to acquire additional holiday leave or to purchase childcare vouchers.

So let’s take a look at how one of these benefits (pension) can affect the individual and their business at the same time. Let’s say an employee sacrifices £10,000 of salary and asks for it to go into their pension instead:

• the employee pays no income tax or NIC on the sacrificed amount, but their pension pot is increased by £10,000 with the prospect of further growth over time.
• the employer saves 15% in employer NICs, which amounts to £1,500 in savings for the business.

What salary sacrifice could mean for company directors

For business owners and directors, especially those drawing a mix of salary and dividends, the pension salary sacrifice model remains one of the most efficient ways to extract profit in a tax efficient way. This gives the individual additional future benefit in the form of an increased pension pot and what that can give.

With the recent NI rate hike adding pressure to the cost of employment, it’s important for your business to consider salary sacrifice. It can be very beneficial, especially for pensions. The sacrificed portion of the salary is not subject to income tax or employee/employer NICs, and the company also benefits from corporation tax relief on their pension contributions.

Let’s take a look at this pension example of salary sacrifice. A director who earns £60,000 is looking to sacrifice £6,000 per year into their pension. The savings would be as follows:

• The Director would save £1,200 in income tax and £120 in their NI contribution giving a total employee saving of £1,320
• The employer saves 15% NIC on £6,000 which would be £900
• The full £6,000 goes into the Directors pension gross, if he chose to do this from his own income the net sum would be £4,680 after tax and NI.

However, please note if a director is already drawing a relatively low salary (eg, £12,570–£20,000) and topping up income through dividends, its likely they have already minimised any NI payment so the advantage is not as great.

The Pros and Cons of Salary Sacrifice for the Business and its Employees

For Business

Salary sacrifice reduces the gross salary used to calculate employer NI, reducing this overall “employment tax”. It comes with several benefits for employers. For example, salary sacrifice can be used to boost pensions savings, especially for directors. This is a highly tax-efficient way to build wealth. There are other options available which bring their own advantages:

·      Offering flexible benefits helps attract and retain staff and can be attractive when it comes to recruiting. When budgets for big salaries are tight, other benefits can help incentivise staff.

·      Benefits can also help support environmental and social values enhancing the business reputation with employees, customers and the general public. For example, electric car and bike schemes support net-zero goals and help with employee wellbeing.

Employers must ensure that salary sacrifice arrangements comply with regulations, and that employees are adequately informed about the scheme’s terms and consequences including the potential drawbacks. It’s important to regularly monitor any salary sacrifice arrangements to ensure compliance at all times while also considering how it will impact other benefits.

For employees

While all this sounds like a good idea, salary sacrifice needs full consideration. Employees need to carefully assess the potential impact on their income. Salary sacrifice reduces their gross salary, leading to a lower monthly income which against a background of increases in the cost of living can make life challenging, resulting in pressures that can affect performance. There are some specific things to consider:

·      Salary sacrifice can affect things like borrowing, as a lower salary can affect loan or mortgage applications as lenders use gross salary as a measure of income.

·      Salary sacrifice can also affect benefits like statutory maternity pay, bonuses, or overtime pay, as these are often based on actual salary levels.

It is important that employees carefully consider the benefits they are receiving in exchange for the sacrificed salary.

Here is an employee example of salary sacrifice that demonstrates the care needed when assessing the actual benefits. An employee is paid a £35,000 gross salary. They can choose to put £2,000 (after tax) into their pension but it is better if their employer does this at source. With salary sacrifice, their new gross salary is £33,000 and the employer pays £2,000 directly into their pension. Doing it this way means the employee saves 20% on the income tax of the £2,000 which equals £400 and saves 8% of NICs on £2,000 which is equal to £160.

By doing it this way, the employee saves £560 in tax and the employer saves 15% in NICs on £2,000, which saves the business £300. But the employee’s salary is now £33,000 and this figure will be used when applying for loans etc.

Conclusion

Salary sacrifice allows employees to receive boosts in their benefits package and at the same time reduce their tax and NI liability. It is particularly useful for improving pensionable benefits and can be an effective tool for improving financial wellbeing, giving the added benefit of employer savings too. With rising employment costs and increasing demand for flexible benefits, salary sacrifice schemes now offer more than just a tax perk and have become a tool to improve workforce planning. But note, while saving tax and NI contributions might seem like a good idea on the face of it, everyone’s needs are different, and employers need to take time to consider if this is the right route for them.

If it is and you want more advice or a demonstration of what can be done including financial modelling showing the direct savings that can be achieved, then here at Kaizen we have the financial expertise to show you how you can take advantage of salary sacrifice. Please do not hesitate to call us on 01482 772261 or email us at info@kaizengroup.uk

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