Salary sacrifice for pay and bonuses - and the mistakes to avoid

Posted: 14/12/2023

Pension contributions are a tax-efficient way of making savings towards retirement. Salary sacrifice helps employers and employees to make the most of tax relief – this article explores some of the benefits and common pitfalls.

How does it work?

The tax relief in question is the relief on National Insurance contributions (NICs), which employer pension contributions benefit from.

NICs are not payable on employer pension contributions, but they are payable on employee pension contributions.

Salary sacrifice makes use of this tax relief: the employee agrees to a contractual variation to their future entitlement(s) to pay and/or contractual bonus (which would otherwise attract NICs), and in return the employer commits to paying a commensurate amount as an employer pension contribution (which does not attract NICs).

Paying pension contributions via salary sacrifice results in a NICs saving for the employer and the employee.

Some employers pass on the employer NIC saving to their employees, but this certainly is not mandatory.

Common pitfalls

Contractual variation
Where a contractual entitlement to pay exists, there must be an effective contractual variation to that future entitlement for salary sacrifice, and therefore the NICs saving, to be effective.

Employers commonly fail to properly implement salary sacrifice by:

not putting in place an effective contractual variation; or
incorrectly believing they can implement salary sacrifice retrospectively.

This is particularly problematic because salary sacrifice cannot be corrected retrospectively – an employee can only enter into salary sacrifice in respect of future pay entitlements.

Bonus sacrifice
Bonus payments can also be sacrificed.

Where a bonus is discretionary the bonus does not, strictly speaking, need to be sacrificed. However, it is good practice to have the arrangement, whereby it is paid into the pension scheme without attracting NICs, properly documented.

Where a bonus is contractual, it must be sacrificed in the same way as pay – ie a contractual variation needs to be in place before the entitlement to the bonus arises.

Depending on the employer’s practices surrounding allocation of bonus, it can be difficult for employers to determine whether a bonus is truly discretionary, which is not determined simply by the employer labelling it as such. Often, attempts to sacrifice contractual bonuses are made too late – rendering them ineffective for the purposes of salary sacrifice and meaning a NIC liability (which attracts interest) remains.

Extra sacrifice payments and the National Minimum Wage
Some employees will ask for one-off salary sacrifices – often in the approach to the end of the tax year, to make use of any unused annual allowances. This is achievable, subject to the usual condition that an effective contractual variation is entered into.

Employers who are minded to facilitate such requests must remain aware of the need to pay the National Minimum Wage.