Salary sacrifice: Overview, definition, and example
What is salary sacrifice?
Salary sacrifice is an arrangement between an employee and employer where the employee agrees to give up part of their salary in exchange for non-cash benefits, such as additional pension contributions, health insurance, or other employee benefits. The sacrificed portion of the salary is typically deducted before tax, which can result in tax savings for both the employee and the employer. This arrangement is often used as part of a broader employee benefits package.
For example, an employee may choose to sacrifice £2,000 of their annual salary to receive additional pension contributions or access a company car as part of their benefits package.
Why is salary sacrifice important?
Salary sacrifice is important because it provides a way for both employees and employers to manage tax liabilities and improve employee benefits. For employees, sacrificing part of their salary can help reduce taxable income, leading to potential tax savings. For employers, offering salary sacrifice schemes can be an attractive way to provide benefits without increasing cash compensation. It also helps in enhancing employee satisfaction and retention by offering flexible, non-cash rewards.
For businesses, salary sacrifice arrangements can be a cost-effective way to offer competitive benefits packages while managing payroll costs.
Understanding salary sacrifice through an example
Imagine an employee earns £40,000 a year. Through a salary sacrifice scheme, they agree to reduce their salary by £2,000 in exchange for additional contributions to their pension. The sacrificed amount is deducted from their gross salary, so the employee’s taxable income is now £38,000. This can lead to lower income tax payments, and the £2,000 sacrificed goes directly into the employee's pension fund.
In another example, an employee may choose a salary sacrifice arrangement to receive a company car. Instead of receiving a salary increase, the employee sacrifices part of their salary in return for the car, which the company provides. The sacrifice is often made before tax, which can result in both the employee and the employer saving on taxes.
An example of a salary sacrifice clause
Here’s how a salary sacrifice clause might look in a contract:
“The Employee agrees to participate in the Salary Sacrifice Scheme offered by the Employer. Under this scheme, the Employee will sacrifice £[amount] of their annual salary in exchange for non-cash benefits, including [details of the benefits]. The salary sacrifice will be deducted from the Employee’s gross salary before tax, and the Employee acknowledges that this will affect the amount of salary subject to income tax and National Insurance contributions.”
Conclusion
Salary sacrifice is a flexible arrangement that can provide tax benefits and enhance the overall employee benefits package. By sacrificing part of their salary in exchange for non-cash benefits, employees can enjoy increased contributions to pensions or other perks, while employers can offer attractive, tax-efficient rewards. It is a valuable tool for both businesses and employees, helping to manage compensation, improve job satisfaction, and enhance long-term savings.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.