Salary sacrifice is also called ‘salary exchange’.
What is salary sacrifice?
Salary sacrifice is an arrangement employers may make available to employees – the employee agrees to reduce their earnings by an amount equal to their pension contributions.
And in exchange, the employer then agrees to pay the total pension contributions. So, any contributions paid to us will be treated as employer only.
Using salary sacrifice means that the employee and the employer pay less National Insurance contributions. Employers may decide to maximise the amount of pension contributions by adding the savings they make in lower employer National Insurance contributions to the total pension contribution amount they pay.
If your employer is using a defined contribution scheme (like The People’s Pension), then the qualifying earnings used to meet the minimum requirement are based on the post-sacrifice level of salary.
Salary sacrifice pension tax relief
With salary sacrifice, an employee agrees to reduce their earnings by an amount equal to their pension contributions.
This means tax relief cannot be claimed because the employee has been taxed on a lower amount of salary.
What are the downsides of salary sacrifice?
Salary sacrifice isn’t for everyone – it’s unavailable if it reduces earnings below the minimum wage. From 1 April 2020 this is £8.72 per hour for those who are over 25, known as the National Living Wage.
There are a few downsides to consider with salary sacrifice:
- Lower life cover (this is because employers generally work out the entitlement as a multiple of salary and salary sacrifice makes that salary lower)
- Lower borrowing available on mortgages (as per life cover the borrowing level is determined by a multiple of a lower salary)
- Entitlement to state benefits eg Statutory Maternity Pay and the State Pension may be affected if your salary falls below the level at which you pay National Insurance contributions.
- If you opt out of a salary sacrifice arrangement, your employer will make an adjustment to your refund to pay back the National Insurance contributions (as the saving in National Insurance contributions only applies if your money remains inside a pension).
Salary sacrifice affects the employee’s terms and conditions of employment and is a matter of employment law, not tax or pensions law.
More information on salary sacrifice/salary exchange: