What is Salary Sacrifice?
A salary sacrifice happens when an employee gives up the right to part of the salary due under his or her contract of employment. This would usually be in exchange for the employer agreeing to provide the employee with a non-cash benefit. It is achieved by varying the employee’s terms and conditions of employment relating to pay.
For example, an employee’s current contract provides for an annual salary of £25,000 with no benefits. The employee agrees with the employer that in future he will be paid a cash salary of £23,000 a year plus childcare vouchers to the value of £2,000.
This arrangement is beneficial, for example, if the salary given up is replaced by a benefit that is exempt from tax and national insurance (NI).
It is possible for a salary sacrifice arrangement that converts cash pay to a benefit exempt from NI to have an adverse effect in certain very limited circumstances. Each of the areas where there could be an impact is considered below.
Salary sacrifice and the National Minimum Wage
A salary sacrifice should not reduce the cash pay to below the National Minimum Wage. The National Minimum Wage provides a legally binding minimum hourly rate of pay to workers.
For workers aged 21 years and over = £6.08 per hour gross.
For workers who are 18 to 20 years, but under 22 years = £4.98 per hour gross.
Salary Sacrifice and Salary-Related Company Benefits
Your benefit in Childcare Vouchers decreases the contractual gross salary you’re entitled to receive. The Company will continue to record your ‘notional salary’, which is your basic salary before opting for Childcare Vouchers. The notional salary can be used as the basis for calculating all salary-related benefits and payments, including overtime, bonuses, pension, life assurance, long-term disability benefit and for your annual pay review. So opting for Childcare Vouchers does not impact any other aspects of your remuneration.
Salary Sacrifice and State Benefits
Entitlement to claim some state benefits (eg statutory sick pay, statutory maternity/paternity pay, statutory adoption pay, maternity allowance, state incapacity benefit, jobseekers allowance, income support, state pension) can be reduced if the amount of NI you pay falls below the 'lower earnings limit' (LEL) for NI (£4,680 in 2008/09) because of salary sacrifice. Under the rules of the Scheme, you are prevented from choosing the benefit if it would reduce your cash pay to less than the LEL, in order to protect your entitlement to claim these state benefits.
Salary Sacrifice and Tax Credits
A salary sacrifice arrangement reduces your taxable cash earnings. Tax credits such as the working tax credit and child tax credit are generally greater at lower levels of taxable earnings. So your entitlement to these tax credits could increase as a result of your participating in a Childcare Voucher Scheme. However, if you receive the childcare element of the Working Tax Credit you should check your individual position very carefully before choosing childcare vouchers. Childcare vouchers that are received as a benefit will reduce your qualifying childcare costs (even if you have given up salary in exchange). This means that the amount of assistance you can claim through tax credits will also reduce. You could lose more in tax credits than you save by taking vouchers, so it is important that this is checked.
See the HMRC website top view the Tax Credit Guidance www.inlandrevenue.gov.uk/taxcredits/index.htm
Salary Sacrifice and Statutory Maternity Pay
Reducing your salary through salary sacrifice may reduce the amount of statutory maternity pay (SMP) you could receive. This is because the higher rate of SMP, which is paid for the first six weeks of the maternity pay period for those who qualify, is based on the amount of your cash earnings. If some of your cash pay has been sacrificed in exchange for a benefit, then it follows that the amount of SMP received will be lower. You can choose to opt out of the Childcare Voucher Scheme but this should be at least 23 weeks prior to due date.
The HM Revenue and Customs website (www.hmrc.gov.uk) contains lots of useful information about salary sacrifice.
For further information about salary sacrifice and state benefits or state pensions you can also check the Department for Work and Pensions website (www.dwp.gov.uk).