Taking the plunge

Asking employees to give up salary is never going to be a popular move. Offering someone the chance to pay less tax and earn more however, is a much more appealing proposition. If structured correctly, salary sacrifice arrangements allow you to do just that. But is it really such a one way bet?

Salary sacrifice is a process by which employees and their employer alter the terms of the employment contract, reducing employees' salary in return for an employer-provided benefit of the same value. This takes advantage of the fact that many benefits are more income tax and national insurance efficient than pay, allowing both employees and their employer to make savings without reducing the overall value of an employee's reward package.

If structured properly almost anything, but the tax position, and so ultimately the savings made, will differ based on HM Revenue & Customs rules. Pension, life assurance, income protection, health screening, childcare vouchers, buying annual leave, bus travel and bikes are all common salary sacrifice benefits in the UK. All of these give income tax savings to employees, and reduced national insurance contributions for both employees and their employer.

Almost any other benefits such as dental insurance, travel insurance and gym membership can also all be provided under salary sacrifice. As these benefits are classed as taxable by HMRC, employees can save national insurance but will pay income tax through the P11D process. There is no saving for the employer from salary sacrificed for benefits like these.

The changes in taxation for high earners have introduced further opportunity for salary sacrifice schemes. As tax free personal allowances are removed for employees earning between £100,000 and £113,500 from April 2010, this group will see an effective tax rate of up to 60 per cent. So someone sacrificing salary from £113,500 to £100,000 for a non-taxable benefit could save in excess of £8,000.

From 2011 individuals with earnings of over £150,000 a year will find traditional pension products are no longer necessarily the most efficient retirement saving vehicle. Setting up an employer funded retirement benefit scheme which operates under salary sacrifice could be around 30 per cent more tax efficient to an employee than offering a defined contribution pension scheme. As executive compensation strategies adapt to the post April 2011 tax regime expect arrangements like these to become more prevalent.

For businesses, the biggest savings will come from pension salary sacrifice. In terms of benefits, one of the few constants amongst all employers in the UK is providing access to a pension scheme. Which means everyone can benefit from pension salary sacrifice. For the average pension scheme total savings can amount to 1 per cent of payroll.