Salary Sacrifice: The Benefits!
There are many ways to make the tax system work for you legally. One way to save money on tax and National Insurance is to work within the Salary Sacrifice scheme: note that our recent blog on Child-Care Vouchers and the new Tax-Free Childcare scheme coming into force in 2015, has already brushed with this idea.
What is salary sacrifice?
Salary sacrifice allows employees to benefit from the tax and NI exemptions available for a range of benefits in kind without costing the employer anything.
How does salary sacrifice work?
Under a salary sacrifice scheme, the employee gives up a certain amount of cash salary in return for a non-cash benefit. Usually the benefit taken in exchange for the salary is one for which a tax exemption is available. However, the scheme can also be used in relation to taxable benefits to take advantage of the NI savings available to the employee by replacing cash salary (which is liable to employee and employer Class 1 contributions) with a non-cash benefit which is liable to employer-only Class 1A contributions.
What benefit is there for the employee?
Where an employee swaps cash salary for a tax-exempt benefit, the employee will save tax and employee Class 1 NI contributions and the employer will also save employer Class 1 NI contributions. Salary sacrifice arrangements are often used to enable the employee to benefit from the tax exemption for Childcare Vouchers.
How does it work?
To be effective, the employee must not be able to revert to the higher salary at will. Care must also be taken where the employee earns near the National Minimum Wage, as the salary sacrifice cannot reduce cash earnings below the threshold. Reducing cash salary below the lower earnings limit for Class 1 NI purposes (£111 per week for 2014/15) may adversely affect entitlement to the state pension, contributory benefits and statutory payments.
Let’s look at an example:
Rose’s employer operates a salary sacrifice scheme enabling employees to swap cash salary for non-cash benefits. Rose takes advantage of the scheme by giving up £2,860 of cash salary p.a. in exchange for Childcare Vouchers.
Benefits to Rose
- As Rose is a basic rate taxpayer, she can take advantage of childcare vouchers of up to £55 per week free of tax and NI.
- By swapping cash salary (subject to both tax and NI) for a tax- and NI-free benefit, Rose saves: tax at £572 (£2,860 @ 20%) and NI at £343.20.
- Rose is £915.20 a year better off!
Benefit to Rose’s employer
- Employer saves Class 1 NI of £394.68 on the foregone salary.
Salary sacrifice arrangements can benefit everyone! Childcare costs are an obvious way to take advantage of the scheme, but another way to benefit is through a Cycle to Work Scheme, that would include the cycle and all the other paraphernalia. There are others, but please get in touch if you’re interested in exploring the options further.