How salary sacrifice can cut Employers’ National Insurance bills

Thanks to the recent Autumn Budget, employers are about to find it much more expensive to pay for staff.

That’s because Chancellor Rachel Reeves announced the Employers’ National Insurance rate that businesses must pay on employees’ salaries will rise by 1.2 percentage points. The Treasury calculates this will cost employers £25bn per year.

Unsurprisingly, this change concerns many British business owners—particularly small and medium-sized businesses (SMEs) working with tighter budgets. The good news is that they have until April 2025 to make arrangements to reduce their tax burden before this change kicks in.

One potential solution that can help employers lower their National Insurance bills (and benefit their employees, too) is salary sacrifice. Currently, only 41% of SMEs offer pension salary sacrifice, compared to 61% of large and 85% of very large organisations.

This discrepancy could be due to smaller firms’ perceptions that salary sacrifice schemes complicate their payroll process. However, the potential cost savings are starting to change people’s minds.

In fact, more than one in five owners of small and medium-sized businesses said after the Budget, they are now “more inclined” to use salary sacrifice arrangements on pension contributions. This is according to a survey of about 900 UK companies commissioned by the Global Payroll Association.

Read on to learn how Employers’ National Insurance is rising, how salary sacrifice reduces employers’ bills, and what to know before implementing a salary sacrifice scheme.

How exactly is Employers’ National Insurance changing?

Currently, employers pay National Insurance contributions (NICs) at a rate of 13.8% of a worker’s earnings above £175 a week. From April 2025, this rate will increase to 15%, and the threshold at which employers start paying National Insurance on each employee’s salary will reduce from £9,100 a year to £5,000.

However, smaller businesses may be unaffected by this change. Employment Allowance, the government programme that helps smaller businesses reduce their employer’s National Insurance costs, will more than double from 6 April 2025.

This means eligible employers can reduce their National Insurance contributions by £10,500, compared to the current amount of £5,000. Additionally, the government is removing the £100,000 threshold, so all businesses with employer National Insurance bills can benefit.

The Treasury estimates that these changes will mean 865,000 employers won’t pay any NICs at all, and over 1 million will pay the same as or less than they did previously.

That said, there are 5.6 million UK SMEs, many of whom will be considering ways to mitigate higher bills in the new tax year.

How does salary sacrifice reduce National Insurance bills?

A salary sacrifice scheme is an arrangement where an employee agrees to give up a portion of their pre-tax salary in exchange for non-cash benefits, such as pension contributions, childcare vouchers, or electric vehicles.

Employees who participate in a salary sacrifice scheme reduce their gross salary (salary before income tax and NICs). Since Employer NICs are calculated as a percentage of an employee’s gross salary, reducing this figure means employers pay less in National Insurance.

This also impacts employees’ finances. If they agree to use salary sacrifice, they technically lower their taxable income, meaning they are liable to pay less in income tax, National Insurance, and potentially student loan repayments.

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The impact on the employee’s take-home pay depends on how much of their salary they sacrifice, their income tax band and other personal financial circumstances. Employees can use an online salary calculator to calculate the actual effect of salary sacrifice.

It can even increase an employee’s take-home pay if they are on the cusp of a higher tax band and sacrifice the balance to re-enter a lower band. This means salary sacrifice can combat fiscal drag, the phenomenon where incomes increase with inflation while tax bands remain the same, causing people to pay more tax or a higher rate of tax. This has become a common problem since the government froze income tax and National Insurance thresholds until 2028.

How salary sacrifice can benefit both employees and employers

According to a recent report in the Financial Times, Steven Leigh, associate partner at professional services firm Aon, calculates that a small company with 10 employees earning £35,000 per year would incur a £9,200 rise in its National Insurance bill following the Budget changes in April.

However, paying 5% of its employees’ income into pensions instead of wages would save £2,625, offsetting about 30% of the increase in employer NICs. The employees themselves would also save in employee NICs from this arrangement by about £140 a year.

Salary sacrifice can help higher-earning staff navigate frozen income tax thresholds by saving more into a pension. And staff on the cusp of the £60,000 threshold, where Child Benefit starts to be withdrawn, could save more into their pension and keep more of their benefits.

Similarly, parents on the cusp of £100,000 could be able to keep valuable childcare benefits, including tax-free childcare and “free” hours of childcare.

Factors to be aware of before you implement a salary sacrifice scheme

If a business won’t be affected by the Chancellor’s increase to Employers’ National Insurance, it may not be worth implementing salary sacrifice before the new tax year. However, reducing gross salaries in exchange for non-cash benefits will likely reduce business costs. Here’s what else employers should consider before offering a salary sacrifice scheme.

Don’t let salaries fall below the National Minimum Wage

Also, beware of employees’ cash earnings falling below their legal minimum wage, which rose during the Autumn Budget. HMRC rules state that the sacrificed portion of an employee’s salary cannot bring their hourly rate of pay below the legal minimum, even if the benefits they receive in return are valuable.

To stay compliant, employers must calculate employees’ hourly rates after the salary sacrifice and compare these with the current National Minimum or National Living Wage thresholds, which vary based on age and whether the employee is an apprentice.

Salary sacrifice can impact maternity and paternity pay

It’s essential that businesses are aware of salary sacrifice’s potential impact on parents. Statutory maternity and paternity pay payments are calculated based on an employee’s average weekly earnings during a specific period, known as the “relevant period.”

Since salary sacrifice reduces an employee’s gross taxable earnings, it can lower the average weekly earnings used to calculate statutory payments. If the reduced salary falls below the lower earnings limit for National Insurance (£123 per week in 2024/25), the employee may lose their entitlement to statutory maternity or paternity pay altogether.

Employers should communicate this potential impact clearly to employees, particularly those on lower wages. Employees planning for parental leave need to consider whether a salary sacrifice scheme is financially beneficial in the short term.

Some businesses may already mitigate this risk by offering enhanced parental pay schemes. These can be based on pre-sacrifice earnings.

Salary sacrifice can reduce student loan repayments

After applying salary sacrifice, student loan repayments are calculated based on an employee’s gross taxable salary. Since the scheme reduces the gross income on which student loan repayments are calculated, employees participating in a salary sacrifice scheme may see a reduction in their monthly loan repayments.

This can increase an employee’s immediate take-home pay, but it may also result in the loan taking longer to pay off and accruing more interest over time. This is particularly relevant for very high earners and those close to repaying their loan in full.

However, many people (particularly those with Plan 2 Student Loans) don’t expect to ever fully repay their student loan. Therefore, any reduction in monthly repayments will be welcomed, as any remaining balance will be cancelled eventually regardless.

How to implement a salary sacrifice scheme

Salary sacrifice can seem complicated to those who have never used it before. However, the system can significantly benefit both employees and employers as long as employers communicate the change effectively. Here’s some guidance on how employers can implement a salary sacrifice scheme and gain a successful uptake.

Work with finance professionals

Salary sacrifice is a high-stakes change to implement, so employers must understand how it works thoroughly. Working with finance professionals will help ensure the scheme is compliant with HMRC and that the business is paying everyone correctly. They can also spot where a proportion of an employee’s sacrificed salary doesn’t bring their earnings below the National Minimum Wage. Check GOV.UK’s guidance on salary sacrifice for employers here.

Decide on the benefits to offer

Businesses will need to assess which benefits are most relevant to their workforce. For example, enhanced pension contributions might be the best option for employees and employers looking to make a significant cost-saving impact, as per the earlier example.

Alternatively, businesses with environmentally conscious employees may offer electric vehicles or cycle-to-work salary sacrifice schemes. With a cycle-to-work scheme, bear in mind that a business is unlikely to achieve an impactful cost saving. This is because a bike only costs a few hundred pounds, so this scheme may not be able to reduce salaries on a financially meaningful scale for the business.

Update employment contracts

A salary sacrifice scheme requires a formal change to employees’ terms and conditions, as it involves reducing their contracted gross salary. Employers must draft a variation agreement for each participating employee. This should detail the salary reduction and the benefit they will receive in return.

Communicate the change to your staff

Employers should explain the scheme’s benefits, how it will affect employees’ take-home pay, and the potential tax savings. It helps to be transparent by saying the scheme also saves employers money. This way, employees know it’s a mutually beneficial arrangement, with no hidden agenda.

Providing examples can help employees understand the value of the scheme and make informed decisions about joining.

Here is an example of how to explain a cycle-to-work salary sacrifice scheme to employees

The cycle-to-work scheme can help you save money on the retail cost of a new bike and accessories.

Simply choose your bike and you will pay for it via salary sacrifice. This means you’re essentially “sacrificing” part of your gross (pre-tax) salary towards the cost of the bike.

Paying with your pre-tax salary reduces your taxable income, so you’ll pay less in income tax and National Insurance contributions. Your employer will also pay less National Insurance contributions on your salary.

The payments will be spread over a set period, and you’ll see them being deducted directly from your gross salary in your payslip. Here’s an example of how much you could save according to the Cyclescheme calculator.

If you select a £500 bike, you may pay 12 monthly instalments of £41.67 from your gross pay, then a £35 ownership fee.

• If you earn £35,000, this £500 salary sacrifice will save you £140 in income tax and National Insurance. This means overall, you only spent £395, so the cycle-to-work scheme saved you 21%.
• If you earn £75,000, this £500 salary sacrifice will save you £210 in income tax and National Insurance. This means overall, you only spent £325 to own the bike, so the cycle-to-work scheme saved you 35%.

Summing up

Offering a salary sacrifice scheme is an effective way for employers to reduce their National Insurance bill. Beyond the cost savings for both employer and employee, salary sacrifice schemes can also enhance employee satisfaction. Employees appreciate perks like additional pension contributions, access to electric vehicles, or help with childcare costs.

However, it’s important to implement these schemes thoughtfully. Employers must clearly communicate how salary sacrifice will impact employees’ take-home pay and ensure compliance with HMRC’s rules.

Please let us know in the comments below if you have any questions, and visit the 1st Formations Blog for more business tips and advice.