Which is better – cash allowance or salary sacrifice?

The choice between a car allowance and salary sacrifice comes down to a balance of flexibility and value.

A cash allowance provides flexibility but offers less value. Salary sacrifice has a more restricted range of choices, but offers the best value, particularly when sourcing a new car. Here’s why.

The hidden costs of a cash allowance

When you opt for a cash allowance, you can spend your payments on your choice of vehicle (subject to company rules on the type of car you can drive if you need it for occasional business use), or potentially something else entirely.

However, this flexibility comes with a cost. The taxman treats your monthly car allowance payments as extra salary, so you don’t receive the full amount. Your monthly payment is reduced by both income tax and National Insurance Contributions. Lower-rate taxpayers also need to be wary of the car allowance taking their overall salary above the 40% threshold (currently income above £50,270).

For a lower-rate taxpayer receiving a car allowance of £500 a month or £6,000 a year, only £350 a month (£4,200 a year) would reach their bank account. A 40% taxpayer would lose just under half their allowance.

What benefits are there to a cash allowance?

An employee is free to spend the remaining cash as they wish (subject to the employer’s grey fleet requirements for employees who cover business mileage in private cars). Money can be put towards a new or used car, any fuel choice and, depending on the funding option, you could eventually end up owning the car as an asset.

It is worth considering that you will have to fund the costs of maintenance and insurance and that you won’t have access to the company’s buying power when trying to source a vehicle.

Before opting for a cash allowance, it is important to consider the full costs involved in sourcing and operating a vehicle, and whether your after-tax allowance can cover the real-world costs you might incur.

How does salary sacrifice work?

Salary sacrifice is an increasingly popular way for employees to fund a car because it can be so cost-effective, depending on the type of car chosen, especially if it is an electric vehicle.

Through salary sacrifice, employees pay for the car using their gross salary, before income tax and national insurance is calculated. This means they are paying for a car partly with money that would have been lost to the taxman had it been taken as salary.

Employers benefit, too, because they reduce their Class 1A National Insurance Contributions, which are calculated as a percentage of an employee’s salary.

A salary sacrifice car scheme ensures everything is arranged for the driver, including payments, tax calculations and other administration. Maintenance and breakdown cover is typically included for peace of mind.

As the driver has to agree to the terms and conditions of the contract, there can also be insurance to avoid early termination penalties or costs related to employees leaving or being long-term absent, for example, because of parenthood.

This is the benefit of having a specialist salary sacrifice leasing provider, who looks after the scheme, the company and the driver.

Will a salary sacrifice car incur company car tax?

Salary sacrifice cars are classed as company cars for tax purposes because the driver benefits from the scheme through their employer, with more buying power and lower VAT costs than a private buyer.

Therefore, drivers have to pay company car tax, which could offset the benefit of paying for a car with pre-tax salary. The solution is to choose a car that incurs the lowest tax, which is why there is soaring demand for electric cars on salary sacrifice schemes.

Company car drivers pay tax on a percentage of the value of their car. The percentage band is defined by the car’s carbon dioxide emissions, rising from 2% of taxable value for a zero-emission car, and rising to a staggering 37% for the most polluting vehicles.

So, if a driver opts for an electric car through salary sacrifice, not only do they reduce its cost by paying with their pre-tax salary, but they also pay barely anything for the privilege.

For example, a 20% taxpayer would pay just £13 a month in company car tax on a £40,000 electric car provided through salary sacrifice.

How flexible is salary sacrifice?

As the vehicle is leased, there can be less flexibility within salary sacrifice schemes. Although drivers can choose from an array of new cars, they must agree to a set number of miles and to keep their car in good condition, otherwise they could incur financial penalties when they hand it back, such as additional mileage penalties and damage rectification work.

As they also sign up to a specific length of lease, they will need to be protected in the case of early termination should they leave their role or have a long-term absence.

How much will a salary sacrifice car save me?

The potential savings from salary sacrifice vary according to the choice of car, the tax band of the driver and the monthly rental charged by the company supplying the salary sacrifice vehicle.

In a typical example, if a lower-rate taxpayer sacrificed £400 of salary every month for a new car, it would only cost them around £300, because around £100 would be made up of money that would otherwise have been lost in tax and National Insurance Contributions.

For a higher-rate taxpayer making the same £400 sacrifice would only ‘cost’ them around £270.

For a detailed calculation, it is always worth speaking to your HR department and the company providing your scheme, as they will have plenty of experts on hand to help you when making your decision and choosing the most suitable car.

Salary sacrifice experts such as Fleet Alliance supply companies with a portal where drivers can access the vehicles available to them and work out the overall costs.

Learn more about our market-leading salary sacrifice solution here.