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No, it’s not a delayed April fool: putting in a request to have your wages cut may actually result in you being better-off at the end of the month.
Salary sacrifice, sometimes known as salary exchange, is a great, if counterintuitive, “life hack”, according to Alice Guy, the head of pensions and savings at the investment platform interactive investor.
It has long been associated with initiatives such as the government’s cycle-to-work scheme, where you give up some of your earnings in exchange for a heavily discounted bike for your commute.
But with hundreds of thousands more people being dragged into higher tax brackets from this month, financial experts are highlighting it as a way of bringing down your personal tax bill, too.
This is particularly the case when salary sacrifice is used to help you save into a workplace pension.
As well as boosting your pension, sacrificing some salary could actually mean your take-home pay increases.
For some higher earners, it may also grant access to child benefit and help with childcare costs. Meanwhile, those on lower salaries may be able to reduce their student loan repayments for a period.
It is estimated that during the 2024-25 tax year, which starts on Saturday, about 700,000 more workers will be pulled into the 40% income tax bracket that applies to those who earn more than £50,270. Meanwhile, tens of thousands more will pay 45% on earnings of more than £125,140. This is because the government has frozen the thresholds for paying income tax and national insurance (NI) until 2028.
This big freeze, which began in 2021, means that when wages rise with inflation, more of your income is eaten up by income and national insurance, something known as “fiscal drag”.
What exactly is salary sacrifice?
It’s a government-backed scheme that involves an employee agreeing to give up some of their (pre-tax) salary and move the amount they would otherwise receive into a benefit that’s “non-cash” based, such as extra employer contributions into their pension pot.
Because the money you sacrifice comes out of your gross pay – the amount you earn before tax and NI is levied – you also lower the amount you owe HM Revenue and Customs. The less you earn, the less tax you pay.
How does it work?
You will need to enter into an agreement with your employer that you want to give up some of your salary.
Not all employers offer salary sacrifice for pension contributions. Quite a few bigger employers offer it, but only about 5% of small- and medium-sized enterprises (SMEs) do, reckons Brendan Shanks, the chief executive of Husky Finance, a firm that helps small businesses set up such schemes.
If your employer does not offer this option, or you are not sure, talk to your HR department, or union or staff representative. If other firms in your sector offer it, you may be able to persuade your employer to sign up.
The contract will detail how much you will sacrifice, for what length of time, and what you will receive as a benefit. You can sacrifice a lot of money if you wish, as long as your employer agrees, but it must never be so much that it takes your pay below the national minimum wage.
Salary sacrifice and pensions
“Most people are making contributions to a workplace pension, but if it’s not via a salary sacrifice scheme, they are missing out on the ‘free money’ available each month as higher take-home pay,” says Shanks.
He uses the example of John, who earns £35,000 a year and contributes 5% of his earnings (£1,750) into his pension via a workplace scheme.
Once income tax and NI are paid, he would take home £27,319.
However, if he were to use salary sacrifice to make his pension contribution instead, he would reduce his gross annual salary to £33,250, but would actually take home slightly more money: £27,459. That’s an additional £140.
The sums are more significant for those on the brink of a tax threshold.
If a worker earning £52,500 a year was to use salary sacrifice to save £2,300 into her pension, she would move herself down a tax bracket – from 40% to 20% – and, in terms of her annual net pay, she would be almost £500 better-off as a result, because it would rise from £39,167 to £39,664.
Jordan Gillies, a partner at the wealth management firm Saltus, says salary sacrifice “is just a technical change to the way you make your pension contribution”. It also benefits your employer, as they no longer have to pay employee national insurance. Some will pay part, or all, of their NI saving into your pension, too, further boosting your pot.
Child benefit and childcare
Salary sacrifice for pension contributions can help those affected by the high-income child benefit charge to keep more of – or all of – their child benefit.
From 6 April, child benefit paid to those on more than £60,000 a year will be clawed back via the tax system (the threshold was previously £50,000). People will now lose all their child benefit once they earn £80,000-plus.
But, says Guy, “for higher earners with kids, pension payments also reduce your earnings when it comes to child benefit and could mean you get to keep more [of the benefit]”.
She also says that when it comes to the government’s new free childcare scheme being rolled out from this month, very-high earners “need to watch out because there’s a huge cliff-edge when you reach £100,000 and you won’t be eligible for any free childcare hours or tax-free childcare. Bizarrely, paying more into your pension could actually mean you end up with more money in your pocket, despite the extra contributions.”
She gives the example of someone with two children earning £105,000 who adds £5,250 to their pension via salary sacrifice to bring their headline earnings just below the £100,000 threshold for eligibility for free childcare.
The result is that this individual is £8,427 better off, including tax saved, plus they are now eligible for tax-free childcare and the free 15 hours offer.
Salary sacrifice car schemes …
Some employers offer car leasing via salary sacrifice, and in many cases you don’t even need to use the car to drive to work. The tax advantages are greatest with electric vehicles. Your employer will lease the car from a company on your behalf. One such company, the Electric Car Scheme, estimates most people will save 30% to 60% on the cost of leasing an EV as a result.
… and bike schemes
The cycle-to-work scheme has been running for more than two decades and has been used by more than1 million people to date. Like car leasing, you pay your employer a monthly fee by giving up some of your earnings, and in return you save on average 23% to 39% on a bike, according to Cyclescheme. There’s now a huge choice on what you can lease, too, including e-bikes, accessories including child seats, and bikes with pricey trailers.
What’s the catch?
There are potential downsides to salary sacrifice – particularly if you are about to buy a home or have a baby. For example, a lower salary may affect the amount you are able to borrow for a mortgage.
As the schemes involve effectively drawing a lower salary, with a lower number appearing on your payslip and bank statements, you need to watch out for how that may impact any borrowing, credit agreements or benefits that are linked to how much you earn.
David Hollingworth at the broker firm L&C Mortgages says a reduction in salary will most probably be considered when someone applies for a home loan and the lender is assessing affordability.
Pension contributions may be considered “discretionary”, meaning they can be adjusted by the borrower quickly and therefore they won’t necessarily be factored in. But, adds Hollingworth, “something like a car lease would be a commitment, so that would have an impact on the amount that could be borrowed”.
Meanwhile, certain workplace and statutory benefits such as maternity pay, life cover, sick pay and universal credit are pegged to your salary, so reducing how much you earn could have an unexpected and costly impact.
In many cases you can exit a salary sacrifice contract early under certain circumstances, including pregnancy, but it is important to do your research and check with your employer.
