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Darren Wingfield

Darren Wingfield

Commercial Manager

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Salary Sacrifice: What Is It & How Does It Work?

Posted on 30/09/22  |  4 Minutes

Making sure you’re offering competitive salaries is one way to attract and retain employees, but there are numerous other options available to you in the quest for employee retention.

There are various non-cash benefits, also known as salary sacrifices, that can serve as a highly effective way to reward and incentivise employees.

If this is something you’re considering for your organisation but you’re not sure where to start, we have you covered. In this article, we’re lifting the lid on what salary sacrifice is, how it works and how it can benefit you and your employees.

Salary sacrifice: what is it?

In order to make informed choices on salary sacrifices, you need to understand exactly what they are.

Sometimes referred to as a salary exchange, a salary sacrifice essentially means that an employee agrees to a reduction of their pre-tax cash salary in exchange for a non-cash benefit.

In the UK, these salary sacrifices include increased employer pension contributions, childcare costs, healthcare and transportation.

A salary sacrifice arrangement is purely voluntary. This means you can’t automatically enrol employees into a salary sacrifice scheme or make participation mandatory.

Any salary sacrifices must be agreed by the employee and included in the terms of their employment contract.

How does a salary sacrifice work?

To implement a salary sacrifice, the first job on the agenda is to agree on the actual cash value of the benefits. After all, you want to make this an attractive prospect to your employees and ensure they’re being fairly compensated for the salary sacrifice.

When calculating the cash value reduction, it’s best practice to place a cap on the amount of salary deduction an employee can take. This will ensure that any reduced cash salary doesn’t fall below the current National Minimum Wage rates set by the Government.


For instance, if an employee who earned an annual salary of £40,000 agreed to reduce it to £35,000 a year in exchange for the employer paying £5,000 extra into their pension each year, this would be a salary sacrifice.

This agreement would obviously need to be outlined in their employment contract and agreed upon by both parties. Any salary sacrifices should also show as pre-tax income on employee payslips to ensure they are exempt from tax and NIC.

Current salary sacrifice schemes available

In the UK, employers are able to offer their employees a number of salary sacrifice schemes.

These include the following:

Cycle to Work

The Cycle to Work scheme is similar to a bike rental agreement. It gives employees the option to buy a bike of their choice or opt into a Cycle to Work package from a third party. The employee or third party who owns the bike then enters into a rental agreement with the employer to pay off the bike over a period of agreed time.

This scheme can be implemented independently or through one of many third-party schemes. Typically, there isn’t a limit on the value of the bike, but it is possible to cap it.

Once the rental agreement ends, employees have a few options:

  • Return the bike
  • Start a new rental agreement on the bike
  • Pay off the remaining value of the bike for full ownership


As an employer, you can also offer a car scheme that works in a similar way to the bike scheme.

Employees sacrifice an agreed portion of their monthly salary in exchange for a new lease car that’s paid off monthly by the employer. The amount will typically also cover any additional running costs of the car outside of fuel - including road tax, car insurance, servicing and general maintenance of the vehicle.

As the car is available to the employee for business and personal use, employers will no longer need to pay business mileage for using their personal car for work travel.

The ownership of the car is registered to the lease company and, at the end of the lease term, the car is returned to them.


If employees are eligible for automatic enrolment in workplace pension schemes, employers must contribute a minimum of 3% to their pension fund - although you can agree on more.

Salary sacrifice is one way employers can contribute additional funds to employee pensions. This means employer contributions increase but the cash salary is reduced by the same amount.

While there’s no limit on how much of their salary an employee can sacrifice in lieu of increased employer pension contributions, salary reductions cannot leave the employee’s salary below the minimum wage rate.

In addition, individuals can’t pay more than £40,000 per year (for the tax year 2022/2023) into their pension savings - so this should be taken into account when calculating salary sacrifice, as well as any contribution caps for the pension provider.

Salary sacrifice and National Insurance and tax contributions

Salary sacrifices are taken out before tax is applied to an employee’s salary - resulting in savings on Income Tax and National Insurance contributions, as their taxable income is reduced.

For instance, if an employee is paid £350 per week before tax, and they’re in a childcare agreement to receive £50 childcare vouchers, only the remaining £300 would be eligible for tax and National Insurance contributions.

From an employer perspective, the savings depend on the National Insurance rates you pay, which are typically set at 15.05%.

Based on this standard National Insurance Contributions rate, employers will recoup 15.05% of any salary sacrifice funds.

For example, for every £1,000 spent on the Cycle to Work scheme, the average employer will recoup £150.50.

Salary sacrifice or non-cash benefits generally need to be declared to HMRC at the end of each tax year. This can be done via the expenses and benefits online form, but be sure to confirm this.

Salary sacrifice benefits

Salary sacrifices boast benefits to both employers and employees, making them an attractive incentive.

For employees, the perks include:

  • Additional cash savings on Income Tax and National Insurance contributions
  • Making expensive outlays like cars and bikes affordable by spreading out payments over a period of time
  • Some salary sacrifices like cars and bikes can be used for personal and business use

Employer benefits include:

  • No business mileage payments for employees who opt in for a lease car scheme, as they won’t be claiming business miles
  • Can help with employee retention and recruitment with attractive non-cash benefits
  • Reduced employer National Insurance contributions as the sacrifice salary isn’t eligible for National Insurance and tax

Salary sacrifice drawbacks

While the benefits generally outweigh the drawbacks of salary sacrifice schemes, it’s worth being aware of the potential disadvantages for employees and employers.

Disadvantages for employees:

  • Reduced salary through non-cash benefits can impact eligibility for credit and mortgage applications
  • The exchange of salary for non-cash benefits will also impact the total value of employment statutory payments such as maternity leave and sick pay
  • Employees must pay Benefit in Kind (BIK) tax at the end of each year for work leased cars. This can amount to more than the savings made from National Insurance and Income Tax if the car doesn’t qualify as an ultra-low emission vehicle

Employer drawbacks:

  • With high staff turnover, costs for car salary sacrifice schemes can be expensive, as employers are left with ongoing monthly payments for the lease term or a charge to end the lease early

Robust accounting is key to successful salary sacrifice schemes, which can be time-consuming. With the help of a professional accountant, though, you can give your employees the benefits they deserve and reap the rewards as an employer - without the worry of any bookkeeping concerns.

Get in touch today and find out how Harlands can help you smoothly integrate salary schemes and stay on top of all things finance for your business.