Salary sacrifice is a popular option for contractors who want to reduce their taxable income while gaining access to non-cash benefits. It is mainly used to make tax-efficient pension contributions.
This guide explains salary sacrifice, its impact on your tax bill, and how to set up a new arrangement if you’re an umbrella company contractor.
What is salary sacrifice?
Salary sacrifice involves an agreement between an employee and employer to reduce the employee’s gross salary in exchange for non-cash benefits, such as pension contributions, company cars, or childcare vouchers.
For contractors, salary sacrifice is usually used for pension contributions, although other benefits are sometimes included too.
The idea is that reducing gross salary lowers the employee’s taxable income, reducing income tax for the individual and National Insurance Contributions (NICs) for both the employer and employee.
What are the key benefits?
Pension Contributions:
This is the most common and tax-efficient benefit under salary sacrifice for umbrella and limited company contractors.
- Pension Tax Relief: Employees benefit from tax relief on pension contributions, meaning that for every £1 of salary that is ‘sacrificed’, a portion that would have gone to the taxman boosts their pension savings instead.
- Contribution Limits: Annual pension contribution limits apply (currently £60,000 in 2024/25), with excess contributions subject to additional tax. Carry-forward rules allow unused allowances from previous tax years to be used in some cases.
Other Benefits:
- Childcare Vouchers: Although these are no longer available for new applicants, contractors already in the scheme can continue using them via salary sacrifice arrangements.
- Cycle-to-Work Scheme: This scheme allows contractors to buy bicycles and equipment tax-efficiently.
- Health Insurance: Some employees may also arrange for health insurance or other benefits via salary sacrifice, though some benefits may incur Benefit-in-Kind taxes.
Salary sacrifice for umbrella company contractors
If you work through an umbrella company, you are an employee. The umbrella handles payroll, taxes, and other administrative tasks. The umbrella company invoices the client and pays you via PAYE (Pay As You Earn). Taxes are deducted at source.
How it works in practice
- As an umbrella company employee, you can reduce your gross salary in exchange for non-cash benefits such as pension contributions.
- The umbrella company sets up the salary sacrifice agreement, which involves lowering the employee’s gross pay and paying the difference into the pension or other benefits. The agreement is written into your employment contract.
- Example: A contractor earning £50,000 per year sacrifices £5,000 towards their pension. This reduces their gross salary to £45,000, lowering their income tax by £1,000 and NICs by £400, while boosting their pension contributions.
- The employer also saves up to 13.8% on the difference in reduced employers’ NICs. Umbrella contractors fund the employers’ NIC themselves – via their assignment rate.
Pros and cons for umbrella contractors
- Pros:
- The umbrella company sets everything up for you.
- You will usually have access to an existing umbrella workplace pension scheme and other benefits.
- Cons:
- Limited control over which benefits are available, as it depends on the umbrella company’s offerings. Not all umbrella companies offer salary sacrifice.
- If your salary is lower, it may reduce the amount of borrowing from mortgage lenders.
- Salary sacrifice may be less flexible than a limited company arrangement, where the contractor has more direct control over benefits and tax planning.
- After including the funds sacrificed, the employee must still receive gross pay of at least the National Minimum Wage.
How to set up a salary sacrifice arrangement
- Speak to your umbrella company about the benefits they offer via salary sacrifice schemes. If you’ve not joined one yet, make sure they offer salary sacrifice – as not all umbrellas do.
- Agree on the salary amount to sacrifice. The arrangement is then written into your contract of employment.
- Ensure the umbrella company deducts the correct tax and NIC treatment from the reduced salary. This is done automatically if they have payslip auditing software (like SafeRec). Unfortunately, there have been cases where unscrupulous umbrellas have ‘skimmed’ contractors’ salaries using inaccurate salary sacrifice calculations, among other methods.
Salary sacrifice – Frequently Asked Questions (FAQs)
Can I make changes to my salary sacrifice arrangement?
Generally speaking, you are discouraged from regularly changing your cash/non-cash benefit ratio. However, occasional changes are usually accommodated if there has been a ‘significant’ change to your lifestyle.
If an employee makes frequent changes, HMRC states:
…any expected tax and National Insurance contributions advantages under a salary sacrifice arrangement will not apply. There are some exceptions to this, Employment Income Manual 42755 gives more information.
Can I sacrifice all of my salary?
No, your gross pay must never fall below the current National Minimum Wage threshold.
Read the government’s official salary sacrifice guidance for employers. This includes further links to relevant chapters of the Employment Income Manual.
Are there any downsides?
Using a salary sacrifice arrangement reduces your gross pay, which might affect your entitlement to some state benefits. It may also reduce the income you can use when applying for a mortgage or loan.
Which umbrella companies offer salary sacrifice?
Not all providers offer this option, so make sure you ask if you’re choosing a new provider. Here are two that do:
Please note that the information provided here is for general guidance only. Always consult your umbrella provider or accountant before making decisions regarding salary sacrifice or other tax-related matters.
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