We noticed we were getting many of the same questions around salary sacrifice so built this page to answer as many of your questions as possible. We are not experts, merely interested parties that like to find ways to reduce people’s tax burden in these difficult times. There are tweaks you can do, but it is important to note that salary sacrifice might give you more money in the long-run, you will have less cash from day to day income.
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Salary Sacrifice: What is it? And How does it Work?
Salary sacrifice, also known as a ‘salary exchange’ or ‘pay sacrifice’, is a legal arrangement between an employee and their employer. In this agreement, the employee agrees to give up, or ‘sacrifice’, a part of their pre-tax salary in exchange for certain non-cash benefits.
The benefits that can be included in a salary sacrifice scheme are wide-ranging and can be tailored to the needs and preferences of the employee.
However, what most people have trouble with is working out what this means for their income tax, student loans, or child benefit. Well, in this page we have tried to answer as many of those question as is feasible.
Does Salary Sacrifice Affect Student Loan?
We have answered this pretty conclusively in this article (which also includes a video!) but the quick answer is yes. Insofar as you will pay less of your student loan back. Here is a shorter example that may help:
- If an individual earning £50,000 annually decides to implement a salary sacrifice of 10% towards their pension, it can influence their student loan repayments.
- Under normal circumstances, this person takes home £2959.55 per month, with £170 being directed towards student loans. After applying the 10% salary sacrifice, the amount directed towards student loans decreases.
- The tax and student loan payments reduce from £1207.12 to £1030.80 per month.
- Although the take-home pay drops by £240 due to the sacrifice, an additional £416 is allocated to the pension pot every month (if you are salary sacrificing into your pension)
- This approach, if we take a reasonable 8% S&P growth rate over 30 years, could yield an extra £248,026.79 in the pension fund, thereby having a significant impact on reducing the burden of the student loan.
This is useful if you are someone with thousand of pounds worth of debt, who wants to know whether or not they should be overpaying their student loan, or simply paying the minimum and wait for it be written off. If you never plan to repay it, then it makes sense to survive on as little money as you can now, and put more into the pension through salary sacrifice. This will mean you will actually be investing instead of paying down a debt you might never pay off (so all those payments are essentially wasted).
Does Salary Sacrifice Reduce Taxable Income?
Yes as we saw in the example given above, salary sacrifice reducing your “Pre-Tax” income, therefore it reduces the amount of income you can be taxed on. National Insurance, Income Tax and Student Loan are all affected by salary sacrifice, it is a good idea to use a tool like this calculator to get the specifics on your situation.
Who Should Avoid Salary Sacrifice?
There are two groups of employees for whom salary sacrifice would not be recommended:
- Those earning below the lower earnings limit: If your income would fall below the lower earnings limit (currently £6,396 in the 2022/23 tax year) by joining a salary sacrifice scheme, it’s best to avoid it. This is because your entitlement to various state benefits, including state pensions, statutory sick pay, and maternity pay, may be affected.
- Those earning close to the minimum wage: Your employer cannot let a salary sacrifice take you under the national minimum wage or national living wage. If you’re in this group, salary sacrifice may not be the best option for you.
Does Salary Sacrifice Impact My Employment Benefits?
Based on the information found, a salary sacrifice arrangement can indeed impact your employment benefits. This is because a salary sacrifice reduces your gross salary, which could potentially reduce your future pay increases, overtime pay, life insurance cover provided by your employer, and any future redundancy payments. These benefits are usually based on your gross pay.
However, many salary sacrifice arrangements address this issue by ensuring all benefits are based on the employee’s original salary, often referred to as the reference salary, notional salary, or base salary. This means that if you’re currently earning a certain amount and your salary is reduced due to the salary sacrifice, your employment benefits can be calculated on the basis that you’re still earning your original salary.
It’s important to note that the arrangement must not reduce your cash earnings below the National Minimum Wage (NMW) rates. Employers must put procedures in place to cap salary sacrifice deduction and ensure NMW rates are maintained.
Please consult with a financial advisor or your HR department to understand the full implications of a salary sacrifice on your specific situation.
Does Salary Sacrifice Affect My Mortgage Application?
Any reduction in your salary could affect your ability to borrow money, such as when buying a house or taking out a loan. One solution is for your employer to provide the lender with a letter of reference, confirming your reference salary. However, bear in mind that some lenders may not accept your reference salary and use the lower post-sacrifice salary when calculating how much you can borrow. This is something you should wary of, especially if locking into longer-term deals (IE a 5 year car lease!)
Salary sacrifice schemes are often used by employees as a way of boosting their pension pot, but what many people don’t realize is that salary sacrifice may also have an effect on their mortgage. Every lender has its own way of assessing applicants, their financial situations, and risk level. Most lenders are going to be more concerned with your gross annual income and debt/income ratio, disregarding any loss of income due to salary sacrifice schemes.
However, some lenders may take a more cautious approach and factor in the lower salary when assessing affordability. This is more likely to be the case if you’re applying for a mortgage with a high loan-to-value (LTV) ratio. The amount of salary that you sacrifice each month will reduce the amount of take-home pay you receive. This may make it more difficult to meet your mortgage repayments, especially if you are on a tight budget.
When you apply for a mortgage, the bank will use your employer as a reference to check your “notional” salary. This is to ensure you can afford the monthly repayments. While your salary sacrifice vehicle will form part of this check, it’s certainly not a bad thing. Compared to running a private car, a salary sacrifice vehicle will actually reduce your monthly outgoings overall. This will also be taken into account by the bank. At the end of it, you’re also left without the worry of a depreciating asset and the running costs associated with having an older vehicle. All in all, your affordability assessment certainly won’t be affected by the appearance of your salary sacrifice vehicle during a mortgage application.
Does Salary Sacrifice Affect My National Insurance Record / State Pension?
Your state pension entitlement is based solely on how many years of national insurance contributions or credits you have, and the amount that you earn is irrelevant. This is good news if you’re part of a salary sacrifice scheme. However, if your salary sacrifice takes your salary below the lower earnings limit, you could lose your statutory maternity pay entitlement altogether. So make sure that you stay above the minimum and top up if needed.
Does Salary Sacrifice Affect My Maternity Pay?
A salary sacrifice arrangement could reduce the amount of statutory maternity pay to which you’re entitled. This is because statutory maternity pay is based on your contractual earnings which count for national insurance contributions. So, if your earnings have been reduced because you sacrificed some salary, the amount of statutory maternity pay you receive may also be reduced. This is definitely something worth bringing up with your employer also consider the lock-in period for salary sacrifice, are you able to enroll monthly, or is it a yearly enrollment. If monthly it is more flexible and you can adjust as you go, and if you need more net income because of the cost of living crisis!
Salary Sacrifice Pension Contributions
Salary sacrifice is a fantastic way to boost your pension savings for some people. However, it’s crucial to consider all these factors before launching into a salary sacrifice scheme. Remember, the idea is that neither the employee nor the employer ends up worse off. However, salary sacrifice pension arrangements could prove costly for employers when their staff are on parental leave.
I’ve used salary sacrifice with my private pension in the past I actually found a way to add £250k to my pension, using an example salary of £50,000. All of this is more important the more you earn, IE if you are a 40% tax payer with two sets of student loans (postgraduate loans at 6% of your income, and undergraduate at 9%) you tax-rate above 50k is 55% (+2% going to national insurance). So 57%. Which means, for every pound of income you put into your pension instead you can make more than double your money.
Say for example you were on £60,000 and you put £200 pounds via salary sacrifice into your pension, your takehome would be £3128, whereas without this salary sacrifice you would take home £3214. In this example you are paying student loans for both undergraduate and postgraduate.
This means you are taking £86 off your pay, and receiving £200 in your pension, a return of 2.3x your money. The numbers get even sillier when you get to the threshold between £100k – £125k.
For example, someone being paid £110,000 would take home £4839.12 without salary sacrifice, but if they put £1000 a month into their pension, their takehome would only come down to £4575. In other words you lose £260 of net income, but get £1000 in your pension. Nearly a 4x return on your money. I know what I would rather do!
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I hope you’ve found this useful, if you have any questions do feel free to reach out to us.