The Legal and Taxation Dangers of Rolling Out a Salary Sacrifice Scheme

Salary sacrifice schemes have been increasingly popular in the last few years, for good reason. As employers have been engaged in the battle for the best talent, finding ways (and particularly cost-effective ways) to offer employees more benefits has rightly become a desirable goal.

Parking for the purposes of this article any commentary on the merits of the forthcoming increase to the national insurance contributions that employers must pay, what cannot be argued is that the pressure on employers to fund this national insurance liability (which for most employers if not all, was rather unexpected and not budgeted for) has resulted in even greater interest in the rolling out of salary sacrifice schemes. Why is that? For at least two reasons: firstly, because the schemes can be used by employers to save some money (by reducing employers’ national insurance contributions) although many employers opt to pass on all of the savings to the employees but, secondly, because the increased cost of employing someone inevitably means (the writer says trying his best to avoid political comment!) that pay rises this year will be reduced as a result, and the introduction of a salary sacrifice scheme could be one affordable way in which the employer (particularly if they pass all the savings on) can improve the employee’s financial lot.

This article is focused on the use of salary sacrifice schemes for the exchange of pension contributions – I am not addressing in this article salary sacrifice schemes relating (for example) to electric vehicles or childcare vouchers. Salary sacrifice schemes for pension purposes make up the largest proportion of the schemes by far. According to research published last year by Workplace Pensions Direct and YouGov, roughly half of UK businesses are using salary sacrifice for pension contributions and I suspect by the end of 2025 that percentage will be much higher.

The premise of this article is not to criticise salary sacrifice schemes or to dissuade any employer from rolling one out, or any employee from opting to join such a scheme; far from it. When used properly these are excellent schemes which I advocate with enthusiasm. Investing in one’s pension is also an admirable objective.

You may sense there is a but coming. There is indeed. Over the last few years, I have come across one or two salary sacrifice schemes that I found slightly concerning. Or, perhaps, it was not the scheme itself that was concerning, but the way in which the scheme was promoted which concerned me. But these were anomalies amongst many hundreds of schemes which were clearly well structured, compliant, and meritorious for all concerned.

However, since the Chancellor unveiled her increased national insurance obligations – and of course, this may just be a coincidence – I have seen far more schemes that meet my ‘concerning’ definition in a few months than I had seen in the past 5 years or so combined.

All of which has motivated me to put this article together, as a cautionary counterbalance to the abundance of content available online as to the merits of salary sacrifice schemes. Not many articles seem to provide any alternative views, and certainly, the large pension scheme administrators (who all have a vested interest in encouraging greater pension contributions) have been able to swamp the search engines with their pro-salary sacrifice articles (and to be clear, in almost all cases, with strong justification).

I wanted to share with employers and employees alike some of the legal and taxation pitfalls that must be carefully navigated in order to avoid costly repercussions.

What is a Salary Sacrifice Scheme?

A salary sacrifice arrangement involves an employee agreeing to reduce their gross salary in exchange for certain non-cash benefits. For employers, such schemes will reduce National Insurance Contributions (NICs), which they may bank for themselves or pass on the savings in full or in part, while employees will in any event benefit from income tax and NIC savings on the sacrificed amount.

Using a simple example, if an employee who is paid £40,000 a year asks to instead be paid £30,000, and for their employer in return to pay an extra £10,000 a year into their pension, the employee will save income tax and NI on that diverted £10,000, and the employer will save employers’ NI on that diverted £10,000 too. Everyone wins, apart from HMRC. That is considered to be ok, as HMRC’s position is that lawful salary sacrifice schemes encourage better pension investment and financial wellbeing which in the long run will help the taxpayer.

However, improper implementation of these schemes can lead to significant risks.

Legal Risks

Employment Contracts: Implementing a salary sacrifice scheme requires a legally binding variation of employment contracts. Failure to properly amend contracts can mean the scheme is not valid, which can mean that employees may claim their original terms remain in force, and/or HMRC can (and will) contend that they are still due the tax and NI they have lost out on. Employers must:

• Obtain clear, positive, and informed consent from employees. This does not mean (for example) that employees can be invited to attend a ‘sales pitch’ Zoom meeting with a financial adviser and then told that it will be assumed they want to enter the scheme unless HR hears to the contrary. It should be an opt-in, not an opt-out.
• Document the changes formally, ensuring compliance with current employment law. Often, we see that salary sacrifice schemes are put together by pension scheme administrators or advisers, who are not employment lawyers, and whether or not they provide template documents, are not assessing the specific requirements of that employer’s contractual position with their employees.

Discrimination Claims: Salary sacrifice schemes must be implemented in a way that does not unlawfully discriminate. For example:

• Excluding part-time employees or those on lower salaries could lead to claims of indirect discrimination.
• Employers must ensure equal access to benefits and justify any difference in treatment with legitimate business reasons that are specific to that employer and are not just generic reasons suggested by the pension scheme administrators.

National Minimum Wage (NMW) Compliance: Salary sacrifice cannot ever reduce an employee’s pay below the NMW, even if the employee asks for it to do so. An employee who earns £30,000 a year and works full-time and asks to sacrifice their salary to £15,000 must be told they cannot – because they would fall foul of NMW. Employers must ensure they have robust systems in place to carefully calculate post-sacrifice wages to ensure compliance with NMW regulations, especially following rate increases to the NMW or any other additional deductions made from pay. NMW compliance is a complex subject and, to be frank, I am not convinced that many pension scheme administrators or financial advisers promoting the use of salary sacrifice schemes fully understand the real risks employers are taking (or if they do, are slow to highlight them). One thing you can be sure of is this: HMRC is not reticent about penalising employers who have breached NMW regulations as a result of salary sacrifice schemes, even where the breaches are technical, minor, and inadvertent. This is perhaps not surprising – if the default position of a salary sacrifice scheme is that HMRC is losing revenue (at least in the short term) they perhaps cannot be criticised for seizing on any opportunity such schemes present to raise revenue.

Notional rates: When entering into a salary sacrifice scheme both parties need to be really clear on what the full terms of their agreement are. Too often the focus is only on the immediate sacrifice and exchange, but the employer and employee need to understand what figures are going to be used – to cite just two examples – in the event of a bonus being paid, or in the case of redundancy. If an employee who was paid £30,000 has opted to now be paid £20,000, and the employer is due to pay that employee a 10% bonus of their annual salary, is the bonus £3,000 or £2,000? Answers on a postcard, please…

Disputes about whether the pre or post sacrificed salary will be used to calculate pay rises, bonuses, redundancy, and other such entitlements all need to be avoided, but so often poor documentation means that these disputes are ever more common.

Misrepresentation: Employers must not tell employees that they are passing on all of the savings they have made from NI to the employees if in fact that is not true. Employers must be very clear and upfront about the position, and if the reality is that the employer needs to bank some or all of the savings to fund the costs of their existence, then they should say that. Employers should also not blindly pass on quotes given by pension scheme promoters that represent to an employee how much they might save without checking that those quotes are likely to be accurate. Employees who enter schemes but subsequently feel they have been induced to do so via misrepresentation may well have legal remedies available to them.

Taxation Risks

Taxable Benefits: Not all benefits offered through salary sacrifice are tax-free. Changes introduced in the Finance Act 2017 restrict tax advantages for many benefits unless they fall within specific exemptions (e.g., pensions, childcare, and cycle-to-work schemes) but for the purposes of this article, we are assuming an employer is offering a benefit that attracts the necessary tax relief. That is not however the end of the story – employers must ensure proper reporting through PAYE or P11D forms as required and ensure there is sufficient skills and knowledge within their payroll teams and HR to make sure no mistakes are made.

HMRC Compliance: In addition to the NMW risks mentioned above, HMRC also closely scrutinises salary sacrifice arrangements, particularly looking for any schemes that might resemble tax avoidance schemes. Or as I more kindly call them, ‘concerning’ schemes. As the rush to mitigate the increased cost of NI arises, it is likely more promoters of such schemes will sense an opportunity. Employers should:

• Maintain clear documentation demonstrating the genuine nature of the sacrifice.
• Avoid retrospective adjustments to salary, as this undermines the arrangement’s legitimacy; and
• Audit and consider who it is that is (a) promoting the scheme to them and (b) who is legally responsible for it. I have seen surprisingly large employers enter a scheme which has been sold to them by ‘pension scheme experts’ without taking advice from their lawyers or accountants. Do not be that employer.

NIC Savings Miscalculations: Employers often rely on NIC savings as a financial incentive for implementing salary sacrifice schemes. However, miscalculations or failure to account for scheme costs (including legal costs, increased payroll costs, and accountancy costs) can erode those savings and in some cases result in financial losses.

Practical Steps to Mitigate Risks

Seek Professional Legal Advice: Employers should consult their employment law advisers before implementing a salary sacrifice scheme to ensure compliance with all relevant regulations. It is likely advice may also be needed from their tax advisers/accountants. Do not ever rely solely on the advice of financial advisers or pension scheme administrators or promoters.

Employees interested in entering a salary sacrifice scheme (for good reason in almost all cases) should not be afraid to seek out their own independent advice too. Maybe a group of employee representatives could contribute jointly to the costs of meeting with an employment lawyer? For example, I have held a fixed-fee consultation with a number of employees to discuss their salary sacrifice scheme documentation – the cost per employee involved in that consultation was little more than £30 each. Who knows – maybe the employer would even fund that cost for a group of employees?

I would recommend that large employers pay for an independent lawyer to speak to their employees or employee representatives about the scheme: that will both provide the employer with some distance and ensure that the employees have access to advice and understand what they are doing.

Conduct Regular Audits: Employers must carry out periodic reviews of salary sacrifice arrangements to help identify and address potential compliance issues, particularly in relation to NMW and taxable benefits. Good employment lawyers will be able to carry out these audits, as will accountants with expertise in NMW regulations.

Provide Clear Communication: Employers must take responsibility to educate employees about the implications of salary sacrifice, including its impact on the notional rates discussed in this article but also statutory benefits (e.g., maternity pay, redundancy pay, and state pension entitlement). Employees must be keen to understand all of this, including whether a sacrificed salary might impact their mortgage borrowing potential.

Implement Robust Systems: Invest in payroll systems and upskill payroll staff so that there is full capability to accurately manage deductions and maintain the records required for HMRC audits.

Employers and employees – do not be SOLD to!: A salary sacrifice scheme is almost certainly going to be a good idea. However, it is not for a pension scheme administrator or financial adviser to sell it to you, and if at any point you feel (whether as an employer or an employee) that a hard sell is being put to you, walk away and take your time. Remember this: someone will be making more money out of increased pension scheme contributions and could be said to have a vested interest. Do not let anyone sell this scheme to you before you understand it properly.

Research has suggested that 7% of employers do not know whether they use a salary sacrifice scheme for pension contributions or not – that is frightening. I also wonder what percentage of employees are unsure of whether they are in a scheme? My own experiences with clients have clearly demonstrated to me that many are being sold a scheme that they do not understand. There is no harm done in most cases (as the scheme is good), but as these ‘concerning’ schemes roll out, harm will be done.

Conclusion

Salary sacrifice schemes are usually a very good thing. However, they are accompanied by significant legal and taxation dangers, and as April 2025 approaches, I fear we will see more and more schemes rushed into. Don’t be that employer or that employee…

If you have any queries relating to a salary sacrifice scheme, please do get in touch with the Employment Team by emailing edisney@leathesprior.co.uk or calling 01603 610911 and we'll be happy to help.