Salary sacrifice is an employment arrangement in which an employee agrees to forego a portion of their salary or wages in return for a non-cash benefit, such as a company car, additional vacation days, or contributions to a retirement savings plan.
How does salary sacrifice work?
To set up a salary sacrifice, the employee and employer need to agree on what portion of the employee’s earnings will be swapped for which benefit. The employee will typically sign a salary sacrifice agreement, which outlines the terms of the arrangement. Afterward, the employer will deduct the agreed-upon amount from the employee’s salary payments and use those funds to provide the benefit.
Does salary sacrifice reduce an employee’s taxable income?
Yes. When an employee agrees to forego a portion of their salary or wages in return for an employer-provided non-cash benefit, the employee’s taxable income is reduced by the amount of the salary sacrifice. This is because the employee’s salary or wages are the basis for calculating their income tax, and if they receive a non-cash benefit instead of cash, they will have less taxable income.
Salary sacrifice can also lower the employer’s payroll taxes, such as Social Security and Medicare taxes in the U.S or national insurance in the U.K. Employers pay these taxes on a portion of their employee’s salaries and wages, and if an employee’s taxable income is reduced through salary sacrifice, the employer’s payroll taxes will also be reduced on that portion of the salary.
What are the most common salary sacrifice schemes?
The most common salary sacrifice benefits are:
- Pension contributions
- Health insurance
- Transportation (car or public transportation expenses)
- Additional vacation days
- Gym memberships
- Mobile phone or internet subscriptions
- Professional development courses
Is there a limit to the amount of salary that can be sacrificed?
Yes. The limits vary depending on the benefit received and the country or jurisdiction in which the employee and employer are located. For example, in some countries, the limit for pension contributions is a percentage of the employee’s salary. In the United States, the limit for 401k contributions in 2021 was $19,500, with an additional catch-up contribution of $6,500 for those aged 50 and over.
Can salary sacrifice schemes impact employees’ entitlement to government benefits?
Yes. Because salary sacrifice reduces an employee’s taxable income, it may also affect their eligibility for certain government benefits.
For example, if an employee sacrifices a portion of their salary for a pension contribution, it may reduce their entitlement to government pensions. Similarly, if an employee sacrifices part of their salary for childcare expenses, it may impact their eligibility for government-provided childcare benefits.