What Is Salary Sacrifice UK and How Does It Work?

Salary sacrifice is a financial arrangement in the United Kingdom, representing a voluntary agreement between an employee and their employer. This arrangement involves an employee agreeing to a reduction in their gross salary in exchange for a non-cash benefit. The primary purpose is to achieve tax and National Insurance (NI) savings for both parties.

How Salary Sacrifice Works

A salary sacrifice arrangement alters an employee’s employment contract, where they agree to a reduced gross pay. In return, the employer provides a non-cash benefit of an equivalent value. This contractual change means that the employee’s taxable income and the earnings on which National Insurance contributions are calculated are lower. Non-cash benefits often receive more favorable tax treatment compared to direct salary payments.

The employee’s pay is adjusted at source, meaning the “sacrificed” amount never forms part of their taxable cash earnings. For instance, if an employee earns £30,000 annually and sacrifices £1,500 for a benefit, their contractual salary becomes £28,500. This reduced salary is then subject to Income Tax and National Insurance contributions. Employers must ensure that the employee’s adjusted cash earnings do not fall below the National Minimum Wage rates. This arrangement requires explicit agreement from the employee and a formal amendment to their employment terms.

Benefits for Employees

Salary sacrifice schemes offer employees financial advantages through reductions in Income Tax and National Insurance contributions. Because a portion of the gross salary is exchanged for a non-cash benefit, the employee’s overall taxable income decreases. This lower taxable income directly translates into a smaller Income Tax liability. For example, a basic rate taxpayer saves 20% on the sacrificed amount, while a higher rate taxpayer saves 40%.

Employees also benefit from reduced National Insurance contributions. By lowering the gross salary, the amount subject to these contributions is also reduced, leading to direct savings. These combined tax and NI savings can increase an employee’s disposable income or allow them to access valuable benefits at a lower cost than if purchased post-tax. Savings are immediate, applied at payroll deduction, negating the need to claim tax relief later.

Benefits for Employers

Employers also benefit from salary sacrifice schemes through a reduction in their National Insurance contributions. Since employer NI contributions are calculated as a percentage of the employee’s gross salary, a reduction directly lowers the employer’s NI liability. For instance, the employer’s National Insurance rate is set to rise to 15% from April 2025. For every £1,000 sacrificed by an employee, an employer could save approximately £150.

These savings provide employers with financial flexibility. Many employers reinvest their NI savings into employee benefits, such as enhanced pension contributions, increasing value for the employee. Offering salary sacrifice arrangements can enhance an employer’s benefits package, making it more attractive to prospective and current employees. This can improve employee satisfaction, aid talent retention, and offer a competitive edge in recruitment, without increasing overall expenditure.

Common Applications

Salary sacrifice schemes apply to a range of non-cash benefits in the UK.

One prevalent application is for pension contributions. The employer pays the sacrificed amount directly into the employee’s pension fund. This means the pension contribution is made from gross pay before Income Tax or National Insurance deductions, leading to immediate tax relief and NI savings. For example, the standard minimum contribution for workplace pensions is 8% of qualifying earnings. Through salary sacrifice, the entire contribution can be made by the employer, saving both parties NI.

Childcare vouchers are another application, though largely closed to new entrants in October 2018. Existing participants can still benefit. These vouchers provide tax-exempt childcare support, reducing the cost of registered childcare.

The Cycle to Work scheme enables employees to obtain bicycles and accessories. Employees rent equipment through their employer via salary sacrifice, spreading the cost over 12 to 18 months and benefiting from Income Tax and National Insurance savings. At the end of the hire period, employees can purchase the equipment for a nominal fee. This scheme promotes healthier commuting and can result in savings of 32% to 47% on the cost, depending on the employee’s tax bracket.

Electric car schemes are another popular salary sacrifice option. Employees lease a new electric vehicle, covering monthly payments from pre-tax income. This results in significant savings on Income Tax and National Insurance. While Benefit-in-Kind (BiK) tax is payable on company cars, rates for ultra-low emission vehicles are very low (e.g., 3% for the 2025/26 tax year), making them highly tax-efficient. These schemes often include maintenance, servicing, road tax, and insurance, bundled into a single monthly payment.

Considerations for Employees

While salary sacrifice offers financial benefits, employees should consider potential implications for their financial circumstances. A primary consideration is the impact on mortgage applications. Lenders assess affordability based on gross income, and a reduced contractual salary could lead to lower borrowing capacity. Some lenders may consider pre-sacrifice gross salary or view certain benefits favorably, while others strictly adhere to post-sacrifice income for affordability.

Participation in a salary sacrifice scheme can also affect an employee’s entitlement to certain state benefits. Statutory payments, such as Statutory Maternity Pay (SMP) and Statutory Sick Pay (SSP), are calculated based on average weekly earnings subject to National Insurance contributions. If a salary sacrifice arrangement reduces an employee’s average weekly earnings below the Lower Earnings Limit (LEL) (£123 per week for 2024-25), their entitlement to these statutory payments could be reduced or even lost. The State Pension entitlement is linked to an individual’s National Insurance contributions record, requiring 35 qualifying years for a full State Pension. If salary sacrifice causes an employee’s earnings to fall below the LEL, it could impact their ability to accrue qualifying years for State Pension.

The level of cover provided by life insurance or income protection policies is often tied to an employee’s gross salary. A reduction in contractual salary might result in a lower payout from these policies. Employees should assess their individual circumstances and consult with financial advisors to understand the full implications of salary sacrifice on their financial planning.