UK Budget 2025: limitations on pensions salary sacrifice will lead to ‘cut-backs’

Pensions salary sacrifice describes an arrangement where, instead of paying contributions directly to their pension, an employee contractually agrees with their employer to give up part of their salary or bonus in return for the employer paying an equivalent amount into their pension.

Currently these payments are treated as employer pension contributions when assessing income tax and NICs, which saves both employer and employee NICs as employee pension contributions are subject to NICs, whereas employer pension contributions are not.

Now UK chancellor Rachel Reeves has announced that pension contributions over the £2,000 threshold paid via salary sacrifice would be subject to national insurance contributions from both employees and employers.

Reeves said the cap was a “pragmatic step” to allow those on low or middle incomes the chance to benefit from salary sacrifice schemes while reducing the cost of relief through salary sacrifice, which relates disproportionately to pension contributions from those on higher incomes.

Capping salary sacrifice relief to £2,000 a year, which will take effect from April 2029, is estimated by the Office of Budget Responsibility to raise £4.7 billion in 2029-30 and £2.6 billion in 2030-31, although this will be sensitive to changes in employer behaviour.

Andy Wright, a pensions law expert with Pinsent Masons, said that these changes would make it more difficult for future generations to be able to build up pensions sufficient for their retirement.

"It looks like the government has again targeted future pensions as a politically expedient way to raise revenues,” he said.

“It is disappointing, given the well-known concerns about future pensions adequacy, that the government is limiting pensions salary sacrifice and making it harder for working people to build a sufficient retirement income."

Other pension contribution mechanisms may be available for businesses to pursue as they plan how best to handle the announced change, and the three-year lead-in to the change will allow companies breathing room to review how best to handle the changes, predicted Dan Naylor, a pension advice expert with Pinsent Masons.

"Fortunately, the changes will only take effect from April 2029, which will give employers plenty of time to prepare and review their current arrangements,” he said.

“We anticipate that many employers will consider restructuring their pension provision in light of the changes."

However, Stephen Scholefield, a pensions expert with Pinsent Masons, said the enforcement of a salary sacrifice cap could have a significant knock-on to pension contributions, which will leave those saving for retirement less well off.

“The changes represent an additional cost which is likely to result in employees building up lower pensions in the future, as employers and employees look to cut back to compensate for higher NI levels,” he said.

“Employers should take time to assess their contribution structures and should think carefully before moving to a non-contributory model, as hinted at by the OBR, under which employers pay all pension contributions but pay lower salaries.

“While saving NICs and sidestepping the measures announced today, that could have wider implications for employment and state benefits.”

This was one of a number of announcements connected to national insurance rules announced by Reeves in Westminster.

Personal tax thresholds and the NIC secondary threshold are to remain fixed until 2031, while a review of voluntary national insurance contributions (VNICs) for British citizens living abroad is to be launched in the new year, along with plans to close access to the cheapest VNICs for individuals abroad.