Ask an employee to ‘sacrifice’ their salary and the prompt response is usually “over my dead body”. Yet bar the unfortunate terminology, the benefits on offer seem rather pleasing. Annie Hayes reports.

Tobin Coles, head of flexible benefits at Jelf, a consultancy that specialises in employee benefits, believes that ‘salary exchange’ is a more appropriate term for what is more commonly referred to as ‘salary sacrifice’.

Coles says that ‘exchange’ describes the process perfectly – that is the giving up of a portion of pre-tax salary in return for a benefit. It is therefore less ‘sacrificial lamb’ kind of stuff than the original term would suggest.

Common exchanges include salary for childcare vouchers, tax-free bicycles for work, mobile phones and pension schemes. Richard Davies, head of employee benefits at benefits provider P&MM, comments that understanding what’s behind the schemes – essentially a government-led push to change behaviours – goes a long way towards removing some of the suspicion that surrounds them.

“Salary sacrifice is operated by government to fast-track initiatives such as encouraging mothers to return to work with childcare vouchers and push green travel with bikes to work.”

The benefits

This, says Davies, plays its part in making salary sacrifice a win-win for employee and employer. The employer and the employee will no longer pay tax or national insurance on the salary sacrificed, and in most cases the benefit is exempt too.

“It’s rare to find a situation when it’s a bad thing. It’s a way of providing benefits that costs the employer and employee less money,” says Coles. Not only does salary sacrifice provide attractive savings but it also encourages employees to save money in the right areas.

According to the 2008 reward survey by the Chartered Institute of Personnel and Development (CIPD), 29% of respondents have adopted salary sacrifice to support pension take-up and contribution amongst employees.

Employers within private sector service firms (37%), followed by manufacturing and production companies (29%) are most likely to be using this practice compared with 19% of public service organisations and 12% of voluntary sector employers. Such arrangements are also more common among larger employers, with 41% of those with 5,000 or more staff operating such an arrangement.

Interestingly, respondents to the survey are evenly split in what they do with the national insurance contributions (NICs) that they save. Around half of employers retain the NICS that they have saved, while the other half shares it with their employees.

Nottingham City Council has deployed childcare vouchers, which has enabled it to recycle the money to expand the range of benefits to meet employee demands. P&MM has worked with the council on its new ‘greentravel2work’ scheme which offers employees’ savings on bus travel to work through salary sacrifice.

In terms of the administration of salary sacrifice schemes, HM Revenue and Custom’s (HMRC) official guidance says that as salary sacrifice is about varying the employee’s terms and conditions (as it relates to remuneration) it is a matter for agreement between the employer and employee. Coles comments that, in the past, the matter of getting a ‘wet signature’ on hard copies has been the cause for considerable headaches.

“Added to this was the issue of telling payroll to make gross pay deductions; it was tricky. But payroll systems have become much more advanced,” says Coles, who explains that for most employers it’s simply a case of just getting the right boxes ticked. It all sounds rather perfect but there are some pitfalls and not everyone is a winner.

The pitfalls

Davies admits that there are large swathes of the workforce that are excluded, particularly those whose sacrifice would take them below national minimum wage (NMW) rates. Those working in retail, for example, where many are on a NMW salary, wouldn’t qualify once the deduction has been made.

“It’s often the people that need the savings the most that can’t have them. There are some that say they are receiving other types of benefits so it’s just, but it’s not an argument that everyone agrees with,” remarks Davies.

It’s not always appropriate for those on maternity pay either, unless they are on full pay, or for those who are about to retire.

“Take a cycle to work scheme, for example. If someone is about to retire in two to three months then it wouldn’t be appropriate to be part of a scheme like this because it’s a product that runs over 12 to 18 months and the retiree would have to pay the balance on retirement – paying the full tax and national insurance liability on that,” says Davies, who adds that pensions via salary sacrifice ought to carry a ‘health warning’ too.

“It’s a loophole really. It’s roots don’t lie in being a government initiative but it’s probably too costly for the government to close it,” says Davies, who has experienced the fallout from clients when HMRC has changed tax breaks and lone suppliers, that subsequently lose their income, let the employer down.

“The employer catches a big cold and is left in a big mess – they might be half way through the scheme and are left with outstanding warranties.”

That, says Davies, is one of the downsides and many will recall the closing down of the home computing initiative but, he says, it’s pretty obvious which schemes have longevity, such as the childcare vouchers and bikes to work schemes.

Flexibility can catch some out too. Davies says salary sacrifice is a yearly commitment – the government does allow for ‘lifestyle changes’ which can offer an olive branch, yet the HMRC isn’t keen to define what it means by the term, instead offering the following advice: “Generally this term is used to refer to unforeseen life events e.g. death of a child, redundancy of a partner, pregnancy of employee or partner, marriage or divorce of employee.”

It does allow the employer to revisit an existing contractual agreement to take account of a change in circumstances.

The other area that can present difficulty is communication. Davies explains: “Most employees are not conversant with tax and national insurance; if you asked them what percentage of tax they paid, most of them wouldn’t be able to tell you.”

What this means is that most are suspicious, wary or often both. Davies says that, in this case, it’s up to the supplier to make the language simple and communicate the benefits.

Coles agrees and says that in organisations where there is the technology to support salary sacrifice, methods of communication are in place, and where there is the ability to track what the savings are, employers “should go for it”. Of course the communication challenge comes about when you need to reach out to employers that aren’t on the end of an email.

Salary sacrifice clearly offers tempting benefits for both sides of the employee-employer equation and used appropriately can offer a win-win situation. Employers must select their schemes responsibly and react to changes whether employee or government driven.

Davies believes that there are other products to be developed too. He predicts that elder-care vouchers will be on the market some time soon. As the understanding spreads so does the take up rates; it’s now up to employers to partner with the right suppliers and take their responsibilities for communication and administration seriously.