Additional important factors which may apply to you as an employee and impact on the benefit of salary sacrifice are:
Working
tax credit and/or child tax credit
Working
tax credit (WTC) and/or child tax credit (CTC)
Entitlement to WTC or CTC
If you do not already have a tax credit award, then, before requesting a salary sacrifice arrangement, you should consider whether it would be beneficial to claim tax credits. You may find it easiest to do this by using the Childcare Indicator provided by HM Revenue & Customs (HMRC). You can then see
- whether you are entitled to WTC, and
- the effect on tax credit awards of taking childcare vouchers.
Tax credits in summary
Tax credits help families on low to middle incomes. There are two tax credits:
- Child Tax Credit (CTC) is for people who are responsible for at least one child or qualifying young person. Nine out of 10 families are said to be eligible for this support.
- Working Tax Credit (WTC) is for people who are employed or self-employed who usually work 16 hours or more a week. The childcare element provides help of up to 80% of qualifying childcare costs up to £175 per week for one child or up to £300 per week for two or more children.
CTC supports families with children, and some 16 to 18 year olds. All families with children, provided the joint annual income is no more than £58,175 (or £66,350 if there is a child under one year old) can claim the credit. WTC tops up earnings to support working people, whether employed or self-employed, on low incomes.
The amount of a WTC award depends on
- the number of hours you work,
- how many children you have, and
- whether you pay any qualifying childcare costs.
Comparing your tax credit award with your savings from vouchers
Employees are encouraged to compare their current tax credit award - or the award that would
be made if WTC were to be applied for - with the award they would receive with the tax and
NIC savings gained by participating in the childcare vouchers scheme. To do this without access
to the HMRC's Childcare Indicator (mentioned above) you would need to follow these steps:
Step 1
Check your current tax credit entitlement (this will be based on your family income and qualifying
childcare costs before participating in the company's scheme).
Step 2
Check your tax credit entitlement based on what your lower family
income will be, for example your original pay less the amount of cash you will have given up
in return for the childcare vouchers. This calculation should also use your lower childcare
costs, for example your qualifying childcare costs less the amount met by the vouchers.
Step 3
Calculate your tax and NIC saving (and pension contribution saving, if any) on taking the childcare
benefit or childcare vouchers instead of cash pay.
Step 4
If the award from Step 2 plus the savings calculated in Step 3 is greater than the
award from Step 1, you are likely to benefit from the childcare voucher scheme.
National
Minimum Wage
A salary sacrifice must not reduce your cash pay to below the National Minimum Wage. The National Minimum Wage provides a legally binding minimum hourly rate of pay to workers – with few exceptions. The levels of minimum wage are
- for workers aged 22 years and above, £5.80 per hour
- for workers aged 18 – 21 years, a development rate of £4.83 per hour
- for workers under, generally, 18 years of age, £3.57 per hour
Personal
and occupational pension schemes
Personal, money-purchase and stakeholder schemes
If you are a member of this type of pension scheme, your decision to sacrifice salary will have no effect on the contributions provided you and your employer continue to pay a percentage of earnings based on notional pay, not the reduced salary reflecting your decision to take vouchers. From this it follows that in that case the pension benefit you receive on retirement will be unaffected by the salary sacrifice.
But if the contributions, whilst remaining at the same percentage rate, are based on your salary reduced by the value of the vouchers, ie the amounts of the contributions are reduced because your salary is reduced, then, given that the pension you eventually receive will be based on the value of the investments made with your and your employer’s contributions, the value of the investments, and hence your pension, will be less than had you not sacrificed salary.
Final benefit arrangements
Whether with a final benefit scheme the contributions are based on notional or actual salary is likely to be determined according to the scheme rules forming part of the trust deed governing the scheme. Irrespective of any reduction in contributions, inasmuch as a final benefit arrangement leads to a pension on retirement based on your earnings during, typically, the last year or last three years prior to retirement, your reduced actual salary during the period of sacrifice is very unlikely to affect your pension. This is because by the time, near the end of your career, that your earnings are being taken into account for calculating your pension, you are unlikely still to be sacrificing salary for vouchers.
Note, however, that were you to die whilst sacrificing salary or shortly after discontinuing the sacrifice, any death-in-service benefit as a multiple of average salary and the pensions for your surviving spouse or partner and family might be based wholly or partly on your reduced actual salary.
If in doubt, ask your HR or payroll department for more information.
State
pensions
Your entitlement to the basic state old age pension, like other contribution-based benefits, is related to the amount of NIC you have paid or are deemed to have paid. Reducing your cash pay through a salary sacrifice may reduce the amount of earnings on which you pay NIC to below the annual Lower Earnings Level (LEL) (£4,940 in the tax year 2009-10), so that you are no longer paying (or deemed to be paying) NIC. Even if your earnings remain above the LEL, this may, because you are paying (or deemed to be paying) less NIC, reduce your entitlement to contribution-based benefits.
Basic old age pension
If you have not paid (or are not deemed to have paid) enough NIC on your income, you may have a reduced State Pension when you retire, or none at all. You should also consider if your S2P could be affected.
State Second Pension (S2P)
The State Second Pension forms part of the State Pension. If your annual pay (less the amount of the salary sacrifice) is between the annual LEL (£4,940) and £13,900, you are treated as if you earn £13,900 for the purposes of calculating your entitlement. If your salary sacrifice brings your pay to less than the LEL your entitlement to the State Second Pension will be reduced. Also, your entitlement to State Second Pension may be reduced if your salary sacrifice reduces your annual pay to a figure between £13,900 and the Upper Accrual Point of £40,040.
State
benefits (general effect on future entitlement)
A salary sacrifice may affect your entitlement to state benefits. The information that follows is based on the rules that apply for the tax year 2008-09. For further information go to the HM Revenue & Customs website - www.hmrc.gov.uk/childcare. If you sacrifice cash pay in return for childcare vouchers, although you will not pay tax or NIC on the value of the vouchers, accepting vouchers also:
- cuts the earnings on which you can pay NIC
- which take your earnings for which NIC are due below the lower earnings limit (LEL). This is the minimum amount of earnings - £412 per month - that an employee needs to qualify for state benefits.
- As your entitlement to some benefits is based on the amount of NIC that you pay, and to others on the amount of your earnings, entering into a salary sacrifice may affect your current or future entitlement to a range of benefits.
For most employees paying less NIC may not adversely affect the benefit entitlement as
- you may still be paying enough NIC to qualify for benefits
- your earnings may still be between £412 and £476 a month (the LEL and the Primary Threshold), so that you are deemed to be paying NIC and you can still build up benefit rights even though you are not actually paying NIC
- you may already be earning below the LEL before the salary sacrifice
- if you only sacrifice salary for a short period, your contribution history will only be affected for that period, so the effect on your benefit entitlement will be minimal.
If you earn between the annual LEL (£4,940) and £13,900 you will be deemed to have earned £13,900 for the purpose of the calculation of your State Second Pension (S2P) accrual. This is to provide a top-up to lower earners.
It is important to note, however, that not only will entitlement to S2P be affected if your reduced earnings fall below the LEL, but it may also be affected if your reduced earnings fall to between £13,900 and the Upper Accrual Point (currently £40,040).
Incapacity
Benefit
Salary sacrifice and contribution-based benefits
Your entitlement to Incapacity Benefit, like other contribution-based benefits, is related to the amount of NIC you have paid or are deemed to have paid. Reducing your cash pay through a salary sacrifice may reduce the amount of earnings on which you pay NIC to below the annual Lower Earnings Level (£4,940 in the tax year 2009-10), so that you are no longer paying (or deemed to be paying) NIC. Even if your earnings remain above the LEL, this may, because you are paying (or deemed to be paying) less NIC, reduce your entitlement to contribution-based benefits.
If your deductible earnings fall below the LEL, you may not be entitled to Incapacity Benefit. If this happens, you may be entitled to Income Support based on incapacity, which is a means-tested benefit.
Jobseeker's
allowance
Your entitlement to Jobseeker's Allowance, like other contribution-based benefits, is related to the amount of NIC you have paid or are deemed to have paid. Reducing your cash pay through a salary sacrifice may reduce the amount of earnings on which you pay NIC to below the annual Lower Earnings Level (LEL) (£4,940 in the tax year 2009-10), so that you are no longer paying (or deemed to be paying) NIC. Even if your earnings remain above the LEL, this may, because you are paying (or deemed to be paying) less NIC, reduce your entitlement to contribution-based benefits.
If your deductible earnings fall below the LEL, you may not be entitled to any JSA (contribution-based), as this benefit is paid at a set amount which cannot be reduced. If you have not paid (or are not deemed to have paid) enough in NIC, you will lose entitlement to this benefit. If this happens, you may still be able to claim JSA (income-based), which is a means-tested benefit.
Maternity
Allowance
Your entitlement to Maternity Allowance, like other earnings-related benefits, is based on your level of earnings, not including any amount sacrificed in return for a NIC exempt benefit. If your cash earnings are reduced to less than the annual LEL (£4,940 in the tax year 2009-10), your entitlement to earnings-related benefits will be reduced.
If your cash earnings fall below £30 per week on average you will lose your entitlement to MA. If your cash earnings fall between £30 and around £125 per week on average you may still be entitled to MA, but at a variable rate. If your average earnings are around £125 a week or more you may receive the full standard amount of MA (£123.06 in the tax year 2009-10).
Income
Support (ie Income Support or Jobseeker's Allowance or Housing Benefit and/or Council Tax
Benefit.)
Salary sacrifice and income-related benefits
If you enter a salary sacrifice arrangement this may affect your entitlement to income-related benefits. If you are receiving Income Support or Jobseeker's Allowance you should contact your local social security or JobseekerPlus office to find out more. If you are not receiving either of these benefits, but are receiving Housing Benefit and/or Council Tax Benefit, you should contact your local authority.
Statutory
Maternity Pay (SMP)
Work-related payments, such as Statutory Maternity Pay, to which you are entitled by law, ie as opposed to your contract of employment, are paid by your employer and are based on your average earnings over a fixed period before you begin to receive them. Sacrificed cash pay will not count as part of your average earnings for calculating these payments, so they may be reduced as a result of a salary sacrifice.
If your average earnings (for SMP entitlement purposes) fall below the annual Lower Earnings Level (£4,940 in the tax year 2009-10), you will lose your entitlement to SMP. If this happens you may still be entitled to Maternity Allowance (MA), which is an earnings related benefit. Even if you are still entitled to SMP, the higher rate, which you can receive during the first six weeks of maternity pay, will decrease, as it is based on the amount of your cash earnings.
If a woman is receiving childcare vouchers in lieu of salary sacrificed, most commentators, including HM Revenue & Customs, suggest that she may for this reason decide that she should terminate the salary sacrifice at the end of the month preceding the start of the Set Period, as it is called, relevant for the calculation of the SMP. (The Set Period is of two months. It ends on the last normal pay day on or before the end of the 15th week (ie the 15th Saturday) before the baby is due.) However, the better view is that the value to the expectant mother of childcare vouchers, in terms of the saving in tax and national insurance (and her pension contribution, if any), right up to the point at which she starts her maternity leave will always be greater than the loss during the first six weeks of her SMP period of 10% of the amount of the vouchers.
The essential point is that returning to a full notional salary instead of maintaining the sacrifice of part of it in exchange for vouchers could increase SMP by up to 90% of £55 per week for the six weeks during which SMP is paid by reference to earnings. Such an increase would be of £297 gross before tax and NI – which for most people will mean between about £205 and £210 net depending on pension scheme membership and hence the NI rate (contracted out or not contracted out). By contrast, continuing to receive vouchers for about five months until maternity leave begins will result in a saving at the rate of £243 x (20% (basic rate tax) + 9.4% (NIC)) = £71.44 per month, ie £357 over the five months, for someone in a pension scheme with contracted out status, and at the rate of £243 x (20% (basic rate tax) + 11% (NIC)) = £75.33 per month, ie £377 over the five months, for someone not in a pension scheme or in a pension scheme with not contracted out status.
Statutory
Sick Pay (SSP)
Work-related payments, such as Statutory Sick Pay, to which you are entitled by law, ie as opposed to your contract of employment, are paid by your employer and are based on your average earnings over a fixed period before you begin to receive them. Sacrificed cash pay will not count as part of your average earnings for calculating these payments, so they may be reduced as a result of a salary sacrifice.
If your average monthly earnings (for SSP entitlement purposes) fall below the annual LEL (£4,940 in the tax year 2009-10), you will lose your right to SSP. If this happens you may still be entitled to Income Support based on incapacity or Incapacity Benefit, if you meet the qualifying conditions. These will be paid at a rate less than the normal rate of SSP. However, you may still be entitled to sick pay through your employer's occupational sick pay scheme if it has one.
Salary
sacrifice and married women paying reduced rate NIC
If you sacrifice cash pay in return for a benefit that is exempt from NIC, and this reduces the amount of your cash earnings to below the LEL (£412 a month in 2009-10), then you will not pay any contributions.
If you are a married woman and your earnings are below the LEL for two consecutive tax years, and you are not self-employed in those years, you will automatically lose the right to pay reduced rate contributions.
If you enter into a salary sacrifice and the reduced amount of cash earnings is between the LEL and the Primary Threshold (£476 a month in 2009-10) you will also not pay contributions but you will be treated as having paid contributions on those earnings. But as those contributions will be at the reduced rate they will not count for benefit or pension purposes.
Where your earnings are between the LEL and the Primary Threshold it might be beneficial for you to change to paying full rate contributions. Although you will not have to pay contributions and your contributions will be treated as paid, the deemed contributions will be at the full rate and will therefore count towards helping you build up entitlement to contributory benefits. If you do choose to cancel your right to pay reduced rate contributions, you cannot change back.
You can find further information about reduced rate contributions in a document entitled Married Women Paying Reduced Rate National Insurance Contributions (NICs) at www.hmrc.gov.uk/faqs/women_reduced_rate.htm
Student
loan repayments
Salary sacrifice may have an effect on student loan repayments. These are calculated as 9% of the excess over gross pay of £1,250 for the month. So an employee opting for the maximum permissible value of vouchers would be likely to see his or her student loan monthly repayment reduced by 9% x £243 = (approximately) £21.87.
What next?
So that you and your employer – and your colleagues! - can start benefiting from childcare vouchers, ask us to get in touch with your employer.
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