Tax Tip 28: How to use a salary sacrifice to save tax and NI

Salary sacrifice is a contractual arrangement whereby an employee gives up the right to receive part of their cash remuneration, usually in return for their employer’s agreement to provide some form of non-cash benefit.

You can still use salary sacrifice to boost your pension but you can now also give up salary in return for benefits such as bikes, childcare vouchers, mobile phones and, in certain areas, bus passes.

It’s worth remembering that if your salary is reduced it can affect state benefits, and you should check with your employer to make sure your bonuses, pay increases and pension benefits won’t also be affected.

Here we explain how giving up a portion of your salary in return for a bike, childcare vouchers and additional pension might work in practice and how much money you will save.

If you are an employer, salary sacrifice can also save you money. Although there will be an administrative cost, employers save on the National Insurance (NI) they have to pay for employees who take part in salary sacrifice.

For example, childcare voucher providers estimate employers save around £370 a year for every employee who orders the maximum number of vouchers.

On your bike
You choose the bike you want, which is bought by your employer. The employer then leases the bike to you. Many employers can reclaim the VAT and therefore have the option of passing this saving on to the employee. The employee’s salary is reduced by the net cost of the bike for the payment period.

As your salary is reduced, tax and NI are also reduced. After the hire period ends, the employer may agree to sell the bike to the employee at a ‘fair market value’ i.e. what a second-hand bike of that make and condition would be worth if sold on the open market.

How it works
Here’s how it might work for someone earning £30,000 a year during tax year 2010-11. Payment period is set at 12 months, but total hire period is set at 36 months – but the employee pays only for 1 year:

Monthly take-home pay after tax and NI: £1,885.31
Full cost of bike: £850 plus VAT of £148.75: £998.75
Employer purchases bike and reclaims VAT
VAT saving passed to employee, so salary sacrificed is: £850
Salary reduced to £29,150 for 12 months
Monthly take-home pay after tax and NI on £29,150: £1,836.50
Difference in monthly take-home pay for 12 months: £48.81
After 36 months employee buys the bike at fair market value plus VAT
On an £850 bike this is now 12% of purchase price plus VAT: £119.85
Total cost of bike
Difference in take-home pay for 12 months: £585.72
Fair market value price of bike + VAT: £119.85
Actual cost of bike to employee: £705.57
Saving on the full cost of the bike (£998.75): £293.18
Childcare vouchers

Vouchers are passed on to your childcare provider
Since April 2005, employees can receive up to £55 a week or £243 a month in childcare vouchers, free of tax and National Insurance.

You receive the same salary as usual, but part of it is paid to you as tax-free childcare vouchers, which you pass on to your childcare provider.

Both parents can claim, effectively doubling the benefit, and higher-rate taxpayers save even more. However, if you are claiming tax credits to help with the cost of your childcare, you might lose out if you claim childcare vouchers.

How it works
Here’s how it could work for someone earning £30,000 a year in 2010-2011 and claiming the maximum childcare vouchers of £243 a month:

Tax and NI paid on salary of £30,000 during tax year: £7,206
Tax and NI paid on salary of £30,000 where max of £243 a month (£2,916 a year) is paid in childcare vouchers: £6,472
Saving over the tax year: £734
Pension boost

Increase your pension payments and save NI
You already get tax relief on your pension contributions, but you can increase what you pay into your pension and both you and your employer can save on NI by giving up part of your salary and directing it to your pension instead.

Our below example shows how a salary sacrifice scheme can boost the pension of someone paying into an employer’s group personal pension scheme (GPP).

In the example shown, the employer would also save on NI contributions (£128) and might be persuaded to add this saving to the contribution, boosting the amount paid towards pension even more.

How it works
Here’s how it might work for someone earning £25,000 during 2010-11 where both employee and employer pay 3% of salary into a GPP. The employer cuts the amount paid in salary by £1,000 but makes a corresponding additional contribution to the employee’s pension fund.

Before salary sacrifice
Employee contribution: 3% of £25,000 (£750 plus tax relief): £900
Employer contribution: 3% of £25,000: £750
Total contribution: £1,650
After salary sacrifice
Employee contribution: 3% of £24,000 (£720 plus tax relief): £864
Employer contribution: 3% of £24,000 plus £1,000 from salary sacrifice: £1,720
Total contribution: £2,584
Increase to pension contribution because of salary sacrifice: £934
Less difference in take home pay: £696
Net boost to pension: £238

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