Should you sacrifice your salary?

Salary sacrifice schemes can cut down the amount of tax you pay on your earnings. But are they always a good idea? Sarah Moore investigates.

Whether or not you think it's a good thing that more and more of your colleagues are taking advantage of a "cycle-to-work" scheme and enthusiastically donning their Lycra under their suits, the fact that Chancellor George Osborne has allowed the salary sacrifice scheme to live on following his latest Budget came as a welcome surprise for many, following speculation that it would be cut.

However, don't get too excited. HM Revenue & Customs has reported a 30% rise in the use of salary sacrifice schemes since 2010, and it has been estimated that the Treasury loses an estimated £5bn a year in National Insurance (NI) payments as a result. The government has now said it plans to review these benefits, so it's likely they won't be left alone for much longer. That means if you want to take advantage, you should act now while you still can.

Salary sacrifice schemes enter an employee and employer into a contractual agreement whereby an employee agrees to receive reduced pay (that's the "sacrifice") in exchange for "non-cash remuneration of equivalent value". This can come in several forms the most popular benefits are childcare vouchers and the cycle-to-work scheme, but other options include company cars and additional employer pension contributions.

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Once you agree to a salary sacrifice, your overall pay is then technically lower. This means you pay less income tax and NI on what you are earning. Your employer will also not have to pay employer's NI contributions on the amount of yoursalary that you sacrifice, saving 13.8%. In cases of added pension contributions, some employers may choose to put their NI savings into your pension, though they don't have to do this.

These schemes are most beneficial to higher earners, points out Adam Palin in the Financial Times, as sacrificing salary in return for a tax-exempt benefit saves workers income tax and NI at their marginal rates. So higher- and additional-rate taxpayers save 42p and 47p in the pound respectively.

Higher earners save less where the benefits in question are not entirely tax-exempt, (such as medical/dental insurance) and just save employees' NI. Those whose salaries currently put them just above a tax regime threshold stand to benefit the most. Salary sacrifice can also help "middle-earning parents", who have previously lost out on child benefit due to their salary level.

But it's not always the best option. Before taking a salary sacrifice, it's worth noting that lower actual earnings could affect future maternity pay or mortgage applications, emphasises the Money Advice Service. A reduced salary could also mean that you receive less life insurance cover through work. Also, where salary sacrifice is being used to boost pension contributions, higher earners should "proceed with caution", warns Palin, to ensure they don't reverse any gains by breaching the lifetime allowance for pension tax relief (which is about to fall to £1m).

Sarah is MoneyWeek's investment editor. She graduated from the University of Southampton with a BA in English and History, before going on to complete a graduate diploma in law at the College of Law in Guildford. She joined MoneyWeek in 2014 and writes on funds, personal finance, pensions and property.