Salary Sacrifice (UK / Australia)
An arrangement where employees contractually give up part of their pre-tax salary in exchange for non-cash benefits, reducing income tax and social security obligations for both parties.
What Is Salary Sacrifice?
Key Takeaways
- ✓Salary sacrifice is a formal agreement between an employer and employee where the employee gives up part of their gross salary in exchange for a non-cash benefit, with both parties saving on tax and social security contributions.
- ✓In the UK, salary sacrifice saves employees 8% in NICs and employers 13.8% (rising to 15% from April 2025) on the sacrificed amount, but only for qualifying benefits like pension contributions, cycle-to-work, and ultra-low emission vehicles.
- ✓In Australia, salary sacrifice (called salary packaging) saves income tax and Medicare levy, with special FBT-exempt caps of AUD 15,900 for not-for-profit and AUD 9,010 for public hospital employees.
- ✓The arrangement must be a genuine contractual change to the employment terms, not just a payroll processing convenience, or tax authorities will disallow the savings.
- ✓Salary sacrifice reduces gross pay, which can affect statutory entitlements like maternity pay (UK), superannuation guarantee calculations (Australia), and loan/mortgage assessments.
Salary sacrifice is one of the most effective legal tax planning tools available to employees and employers. The concept is simple: instead of receiving your full cash salary and then paying for a benefit with after-tax money, you agree to receive less salary and have the employer provide the benefit directly. Because the benefit is provided before tax is calculated, both parties save. In the UK, it's commonly used for pension contributions, cycle-to-work schemes, and electric vehicle leases. In Australia, it's used broadly for everything from superannuation top-ups to mortgage payments (in the not-for-profit sector) and novated car leases. The mechanics differ between countries because the tax systems work differently, but the core principle is identical: reduce taxable salary, receive an equivalent-value benefit, pay less tax overall. Despite the tax advantages, salary sacrifice isn't free money. It reduces your gross salary on paper, which affects calculations tied to gross pay: statutory sick pay, maternity pay, mortgage affordability assessments, and even State Pension accrual in some cases. Understanding these trade-offs is essential before committing.
Salary Sacrifice in the UK
The UK's salary sacrifice framework has been tightened significantly since April 2017, when HMRC restricted which benefits qualify for tax advantages.
Benefits that still qualify for full tax and NIC savings
Since April 2017, only four categories of benefits retain full tax and NIC advantages through salary sacrifice. Employer pension contributions: the most common use, with no cap on the amount (subject to annual allowance rules). Cycle-to-work schemes: bicycles and cycling equipment for commuting, typically structured as a hire agreement. Ultra-low emission vehicles (ULEVs): cars with CO2 emissions of 75g/km or less, which in practice means electric or plug-in hybrid vehicles. Childcare vouchers: closed to new applicants since October 2018, but existing participants can continue. For these four categories, the sacrificed salary isn't subject to income tax or NICs for the employee, and the employer saves NICs on the reduced salary.
Optional remuneration arrangements (OpRA) rules
For all other benefits provided through salary sacrifice, the 'optional remuneration arrangements' rules apply. Under OpRA, the employee is taxed on the higher of the cash salary given up or the taxable value of the benefit received. This effectively eliminates the tax advantage for most non-qualifying benefits. For example, if an employee sacrifices GBP 3,000 of salary for a benefit worth GBP 2,500 (say, a gym membership), they're taxed on GBP 3,000 (the higher amount). The sacrifice produces no tax saving and may actually cost more than paying with after-tax money. Before 2017, salary sacrifice worked for almost any benefit. The OpRA rules closed that window except for the four protected categories.
How UK pension salary sacrifice works in practice
The most popular use of UK salary sacrifice is for pension contributions. Here's how it works: the employee agrees to reduce their gross salary by, say, GBP 500 per month. The employer adds that GBP 500 to the pension contribution, along with the NIC savings (13.8% of GBP 500 = GBP 69). The employee's pension receives GBP 500 (or GBP 569 if the employer passes through NIC savings), the employee saves GBP 40 in NIC (8% of GBP 500), and the employer saves GBP 69 in NIC. Some employers pass the full NIC saving to the employee's pension. Others split it. Some keep it. This is a negotiation point. For higher-rate taxpayers (40% income tax), the savings are even larger because pension contributions through salary sacrifice avoid both 40% income tax and NICs, compared to relief-at-source contributions which only get basic rate tax relief automatically.
Salary Sacrifice in Australia (Salary Packaging)
In Australia, salary sacrifice is more commonly called salary packaging. The framework is broader than the UK's, with particularly generous provisions for not-for-profit and public sector employees.
How it works for superannuation
Employees can sacrifice part of their salary into their superannuation fund as concessional (pre-tax) contributions. These are taxed at 15% inside the super fund instead of the employee's marginal rate (which could be up to 45% plus the 2% Medicare levy). The combined concessional contribution cap (employer super guarantee plus salary sacrifice) is AUD 30,000 per year for 2024/25. For a high-income employee, sacrificing AUD 10,000 into super saves roughly AUD 3,200 compared to receiving the cash and investing it after tax. The super guarantee (currently 11.5% of ordinary time earnings) counts toward the cap.
FBT-exempt salary packaging for not-for-profits
Australian not-for-profit organizations (charities, hospitals, ambulance services, public benevolent institutions) have access to generous FBT (Fringe Benefits Tax) exemptions that make salary packaging exceptionally valuable. Employees of these organizations can package up to AUD 15,900 per FBT year (for charities and PBIs) or AUD 9,010 (for public hospitals) in everyday expenses like mortgage payments, rent, school fees, or credit card bills. The packaged amount is paid from pre-tax salary, reducing income tax. Additionally, they can package a further AUD 2,650 in meal entertainment and holiday accommodation expenses. This effectively creates a two-tier labor market where not-for-profit employees receive significant tax advantages that commercial sector employees don't. It's one reason many healthcare and social services professionals prefer working in the not-for-profit sector despite lower base salaries.
Fringe Benefits Tax considerations
In the commercial sector, most salary-packaged benefits (other than superannuation) attract FBT at 47% of the grossed-up taxable value. This often negates the income tax saving, making salary packaging uneconomical for most benefits. The exceptions are portable electronic devices (one per FBT year, such as a laptop or tablet), car parking (subject to caps), in-house benefits (discounts on employer's products/services), and novated leases (which have their own FBT treatment). For commercial employers, the practical salary sacrifice options are: superannuation, novated car leases, and a limited set of FBT-exempt benefits. The not-for-profit FBT exemption is what makes Australian salary packaging so distinctive compared to other countries.
UK vs. Australia: Key Differences
While the principle is the same, the implementation differs significantly between the two countries.
| Feature | UK | Australia |
|---|---|---|
| Primary tax savings | Income tax + NICs (employee and employer) | Income tax + Medicare levy (2%) |
| Pension/super sacrifice | No cap on amount (annual allowance rules apply separately) | Capped at AUD 30,000 total concessional contributions |
| Qualifying benefits (post-2017) | Pension, cycle-to-work, ULEVs, legacy childcare vouchers only | Super (all employers); broad FBT-exempt items (NFPs); novated leases (all) |
| Not-for-profit advantage | No special salary sacrifice rules for NFPs | AUD 15,900 FBT-exempt packaging cap for NFP employees |
| Employer social security saving | 13.8% NIC (rising to 15% April 2025) | No direct employer payroll tax saving in most states |
| Impact on retirement | May reduce State Pension if salary falls below lower earnings limit | Super guarantee calculated on pre-sacrifice OTE (since 2020 ruling) |
Risks and Pitfalls
Salary sacrifice isn't risk-free. Both employees and employers should understand the potential downsides.
Impact on statutory entitlements (UK)
Statutory maternity pay (SMP), statutory paternity pay, statutory sick pay, and other statutory payments are calculated on actual earnings. If salary sacrifice reduces an employee's weekly earnings below GBP 123 (the lower earnings limit for 2024/25), they lose entitlement to SMP entirely. Many employers mitigate this by including a clause that temporarily suspends salary sacrifice during maternity leave. Redundancy pay is also calculated on actual salary, so long-term salary sacrifice reduces redundancy entitlements. Employees should be made aware of these impacts before entering into an arrangement.
Impact on superannuation guarantee (Australia)
Before 2020, salary sacrificing into super could reduce the employer's super guarantee obligation because the guarantee was calculated on the lower, post-sacrifice salary. The ATO issued a ruling in 2020 clarifying that the super guarantee should be calculated on ordinary time earnings before any salary sacrifice reduction. Most employers now comply, but employees should verify that their employer calculates the 11.5% guarantee on their pre-sacrifice salary, not the reduced amount.
Tax authority scrutiny
Both HMRC (UK) and the ATO (Australia) scrutinize salary sacrifice arrangements. The key requirement is that the arrangement is a genuine contractual change. The employment contract must be varied to reflect the new, lower salary. The employee can't simply 'opt out' at any time and receive the full cash salary retrospectively. If the arrangement looks like it's just a payroll mechanism rather than a genuine salary reduction, the tax authorities can disallow the savings and impose penalties. Both countries require that the arrangement is set up prospectively (before the salary is earned, not retroactively applied to salary already earned).
Electric Vehicle Salary Sacrifice (UK Focus)
Electric vehicle (EV) salary sacrifice has become one of the fastest-growing employee benefits in the UK, driven by favorable Benefit in Kind (BiK) rates.
Why EV salary sacrifice is so popular
Pure electric vehicles have a BiK rate of just 2% in 2024/25 (rising to 3% in 2025/26, 4% in 2026/27, and 5% in 2027/28). This means an employee driving a GBP 40,000 electric car pays BiK tax on just GBP 800 of deemed benefit per year (2% of GBP 40,000). For a 40% taxpayer, that's GBP 320 per year in tax. The combination of low BiK, NIC savings, and no fuel costs makes EV salary sacrifice significantly cheaper than buying or leasing a car privately. Typical savings range from 30% to 60% compared to a personal contract hire.
How EV salary sacrifice schemes work
The employer leases the vehicle and provides it to the employee as a benefit. The employee's salary is reduced by the lease cost (including insurance, maintenance, and breakdown cover in most schemes). The employee pays BiK tax on the low EV rate. Both employee and employer save NICs on the sacrificed salary. At the end of the lease (typically 2 to 4 years), the employee returns the car or has the option to purchase it at market value. Providers like Octopus Electric Vehicles, Tusker, and LeasePlan specialize in employer EV schemes and handle the administration, insurance, and fleet management.
Implementing Salary Sacrifice: A Practical Guide
Rolling out a salary sacrifice scheme requires coordination between HR, payroll, legal, and employee communications.
- Legal: draft a salary sacrifice agreement that formally varies the employment contract. Include the amount sacrificed, the benefit received, the duration of the arrangement, terms for opting out, and impact on other employment terms. Have employment counsel review it.
- Payroll: configure payroll software to process the salary reduction, adjust NIC calculations, and route the sacrificed amount to the correct provider (pension fund, leasing company, etc.). Test thoroughly before go-live.
- Tax compliance: ensure the arrangement meets HMRC or ATO requirements for genuine salary sacrifice. Maintain records of employee agreements, effective dates, and any changes. Be prepared for audit.
- Employee communication: explain the savings clearly with worked examples. Highlight the trade-offs (reduced statutory pay, mortgage impact, pension impact). Provide a calculator tool so employees can model their personal savings. Offer one-on-one sessions for employees with questions.
- Minimum wage check: verify that no employee's post-sacrifice salary falls below the national minimum wage (or National Living Wage in the UK). This is a hard legal floor that can't be breached regardless of the benefit's value.
- Review annually: tax rates, NIC rates, FBT exemptions, and benefit rules change regularly. Review the scheme each year to ensure it remains compliant and financially beneficial.
Frequently Asked Questions
Does salary sacrifice affect my mortgage application?
Can I opt out of salary sacrifice at any time?
Is salary sacrifice legal?
Does salary sacrifice reduce my employer's super guarantee in Australia?
What's the difference between salary sacrifice and payroll giving?
Written by Adithyan RK