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Using salary sacrifice to reduce the tax you owe is a great hack to be more tax efficient. But how does it work and who actually wants to sacrifice some of their salary? Keep reading for the answers to these burning questions! 🔥
In this guide, we’ll cover:
Salary sacrifice is a scheme where you give up part of your salary in exchange for a non-cash benefit. This can be bigger pension contributions, a travel card, a work phone etc.
The 1 million dollar question. Who the heck would be up for this? Generally, higher earners benefit the most because it can be a tool to increase your take home pay.
But how could that be true? 🤯
Basically, the salary sacrifice scheme reduces your tax liability by replacing cash salary with non-taxable – or tax relieved – income. An example could be that you sacrifice £1,600 of your salary for a bike through your employer’s salary sacrifice scheme.
Here’s an example. Imagine you have a £101,000 salary, and you exchange £1,600 of that on a bike.
|Tax rate (%) paid on bike||Cost to you||Gross salary (cash)||Taxable income 👀||Tax-free income|
|With salary sacrifice||0%||£0||£99,400||£86,830||£14,170|
|Non-salary sacrifice benefit||40%||£640 (tax deducted from salary)||£100,360||£87,970||£13,350|
|Without any employee benefit||40% + 20%||£1,600(bought after tax from take home pay)||£101,000||£88,930||£12,070|
As you can see from the above table, your taxable income is highest when you buy a bike outside any scheme, whether that’s a benefit in kind or salary sacrifice. (We’ll come onto the difference between these things later.)
With salary sacrifice, you avoid being tipped into the 60% tax bracket which affects people who earn between £100,000 – £125,140. Instead, your £101,000 salary is made through a combination of cash and non-cash remuneration.
Things changed. People changed.
Pre-2017, a long list of benefits was eligible for totally tax-free salary sacrifice. Think gym membership, travelcards, shopping vouchers etc. But then ex-Chancellor of the Exchequer Philip Hammond introduced some new rules which cut back on the
fun tax-efficiency, fearing that many employees and employers were sidestepping their tax liability via salary sacrifice.
Today, many company perks are now taxable. They’re still more tax-efficient than a cash salary, but you get a tax relief on them rather than them being non-taxable benefits. The tax is recorded and paid using a form called the P11D.
Here are the non-taxable perks that Hammond left uncut:
Contributing more to your pension via a salary sacrifice scheme is a good tactic to be tax efficient. Your pension contributions are taken from your salary before tax is deducted, reducing your taxable income. In other words, your take home pay is higher.
If you earn less than £50,270 per year, you also get an automatic 20% tax relief on your contribution.
If you’re a higher or additional rate taxpayer (so you earn between £50,271 – £125,140 or £125,141+ respectively) you can claim an additional 20% to 25% tax relief. But to claim this, it’s not automatic. Unfortunately, you’ll have to submit a self assessment. Fortunately, TaxScouts is a thing 😉.
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HMRC will basically give you back the tax that you paid on the income that you used for your pension contribution.
In your case you earned £49,000 and contributed £1,000 to your pension.
You get £250
Your pension provider will automatically get this for you and add it to your pension pot.
Your pension pot will now be worth £1,250.
Well, the question here is… who are you?
No, seriously. The answer to this really does depend on who you are. There are some salary sacrifice schemes that are beneficial outside the financial gain.
But if it’s financial gain you’re after – and who could blame you – salary sacrifice schemes can be a really good way to sidestep the dreaded 60% tax. Although it’s not an official income tax rate, it’s what you’re charged when you earn over £100k and you start to lose entitlement to your tax-free personal allowance.
So if you’ve just started earning £100k+ but you don’t earn £125,140+, salary sacrifice is a good way to make your tax-free income stretch.
Here are some examples of both taxable and non-taxable benefits that you might be offered through your employer.
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