Chancellor Rachel Reeves has confirmed that the amount you can contribute to your pension via salary sacrifice will be capped at £2,000 a year.
Any contributions above the new £2,000 cap will no longer be exempt from National Insurance (NI) from April 2029.
There is currently no limit on the amount that you can put into your pension under salary sacrifice to benefit from less income tax and NI.
How salary sacrifice works
Salary sacrifice is an agreement between you and your employer where you give up part of your pay in exchange for a non-cash benefit, such as a contribution into your workplace pension.
As your overall salary is lower, the amount of income tax and NI you pay is reduced. Your employer also saves the NI that would have been payable on the portion of your salary that gets directed to your pension.
From April 2029, if an employee makes pension contributions via salary sacrifice, they’ll pay the full rate of NI on any amount above £2,000: 8% on a salary of less than £50,270 and 2% on income above this.
HMRC figures show that around 30% of private sector employees and 10% of public sector employees use a salary sacrifice arrangement for their pension contributions.
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The impact of a salary sacrifice cap
According to the Office for Budget Responsibility, the change in rules will raise £4.7bn in 2029-30, but there are concerns that it will disincentivise pension saving at a time when many people aren’t saving enough for their retirement.
Calculations by AJ Bell show that someone earning £55,000 a year and contributing 10% via salary sacrifice would lose £188 in their take-home pay each year, once the £2,000 cap comes into force.
Additional analysis by AJ Bell indicates that someone aged 35 earning £50,000 a year could face a hole in their pension of £22,060 by age 65 as a result of the cap.
This assumes they already have a pension fund of £30,000 and save an overall contribution of 5% personally, with another 3% coming from their employer.
The change will also come at a cost to employers. According to a survey by the Association for British Insurers ahead of the Budget, around a third of businesses said they would reduce their contributions to an employee’s pension as a result of the cap, while just under half would reduce other employee benefits and services.
Find out more: how much will you need to retire?
What the Budget means for retirees
The Chancellor also confirmed that the state pension will rise by 4.8% next year thanks to the triple lock guarantee.
This means the full state pension will be worth £12,548 a year from April.
However, the extension of the freeze on income tax bands will prove bad news for pensioners as more will pay tax for the first time or incur a higher rate.
Some 8.7 million people of state pension age or older are projected to pay income tax on their retirement savings in 2025-26 – a rise of 1.9 million more older taxpayers from 10 years ago (2015-16).
- Find out more: pension tax calculator
No change to tax-free pension cash
Rachel Reeves confirmed in her Budget speech that the pension tax-free cash allowance will remain unchanged.
Ahead of the Budget, there was speculation that the government might reduce the size of the tax-free lump sum people can withdraw from pensions after the age of 55. The allowance is currently set at 25% of your pot, up to a lifetime cap of £268,275.
- Find out more: how pension withdrawals are taxed