Salary sacrifice schemes: tax advantages and pitfalls
Salary sacrifice is an arrangement where an employee agrees to give up part of their gross salary in exchange for a non-cash benefit. The benefit to the employee is that the sacrificed salary is not subject to income tax or NI contributions — so the effective cost of the benefit is lower than if they bought it out of net pay. The benefit to the employer is that employer NI is not paid on the sacrificed amount, which can be a meaningful saving at scale.
The most common salary sacrifice schemes are: pension contributions, cycle-to-work, electric vehicle leasing, childcare vouchers (closed to new entrants since 2018 but still active for existing holders), and the purchase of additional annual leave.
Pension via salary sacrifice works like this: instead of the employee paying their pension contribution from net pay (after tax), the employer pays both the employer and employee contributions from gross pay. The employee's gross salary is reduced by the contribution amount. The resulting saving in employee NI (8% on the contribution, within the relevant band) and employer NI (15% on the contribution) is typically split between the two parties, with the savings sometimes used to increase the pension contribution further.
For pension auto-enrolment, salary sacrifice pensions must still meet the qualifying criteria. The employee's total pension contribution (from the sacrificed salary plus any additional employer contribution) must meet the minimum 5% of qualifying earnings. The contract of employment must be formally varied whenever a salary sacrifice arrangement changes, because the employee's gross salary is legally changing.
The pitfalls of salary sacrifice are real. When gross pay is reduced, it affects any pay-based calculations: statutory maternity pay is calculated on reduced earnings, which can disadvantage employees who sacrifice a significant portion of salary. Mortgage references based on payslip gross pay may show a lower figure. Some means-tested benefits are assessed on gross income before sacrifice, which may affect employees who are close to qualifying thresholds.
Salary sacrifice also does not work for everyone. Employees whose pay after sacrifice would fall below the National Living Wage (or National Minimum Wage for their age group) cannot enter a sacrifice arrangement — the sacrifice cannot reduce pay below the minimum wage floor.
For cycle-to-work schemes, the government-approved limit is £1,000 for standard bicycles. Above £1,000 (and for electric bikes, where the limit is different), the scheme operates under a consumer credit exemption, which requires specific scheme approval.
For EV leasing via salary sacrifice, the tax advantage is currently substantial because BIK rates on fully electric vehicles are just 3% (rising gradually). A well-structured EV scheme can reduce the real cost of an electric vehicle significantly for both employer and employee.
See our pension auto-enrolment guide for how sacrifice interacts with auto-enrolment rules, and payroll for part-time employees for how sacrifice affects pro-rata salary calculations.
Mellow supports salary sacrifice configurations for pension, cycle-to-work, and EV schemes, with automatic adjustments to statutory payment calculations. [Start a free trial →](https://mellowhr.com/register)