Autumn Budget 2025: Pensions

Salary sacrifice

Current position

Employer pension contributions are not subject to income tax or National Insurance contributions (NIC). Whilst employee pension contributions are also not subject to income tax, they are subject to NIC deductions.

Salary sacrifice is a voluntary agreement, under which an employee agrees to give up part of their salary in exchange for the employer paying an equivalent amount as an additional employer pension contribution. This leads to NIC savings for both employee (8% on salaries under £50,284 and 2% on income above that) and the employer (typically 15%). Alternatively, the employer may use part of the NIC saving to increase pension contributions for their workforce.

The use of salary sacrifice in this way can also have a wider impact on employees (particularly high earners), including the level of their student loan repayments, their eligibility for child benefit and/or childcare allowances and their tax band for income tax purposes.

What is changing and why

With effect from 6 April 2029, NIC tax relief on pension contributions made through salary will be capped so that it is only available for up to £2,000 of contributions a year. Salary sacrificed pension contributions above £2,000 will be subject to employer and employee NICs, like other employee pension contributions. The change only applies to arrangements that are made via salary sacrifice so full NIC relief will still be available in respect of normal employer contributions. The Government has also explicitly confirmed that employees who choose to sacrifice salary to receive tax free childcare or child benefit can keep doing so.

The changes will require primary and secondary legislation which will be introduced in due course. For now, the Treasury has published a short guidance note, with further guidance to follow.

The policy supports the Government's objective that tax rises should not impact the lowest paid with arguments in favour of the change being:

• it currently costs the Treasury an estimated £4.1bn a year, the majority of which (£2.9bn) is savings for the employer. Without reform, the cost was predicted to increase to £8bn by 2030/31
  
  
• only 25% of all employers offer salary sacrifice, with most of those coming from the private sector
  
  
• it is mainly used by large and medium sized employers, who typically have a greater number of high earners and is not available to employees being paid the minimum wage
  
  
• according to HMRC analysis, setting the cap at £2,000 means that 74% of basic rate taxpayers and their employers will be unaffected by the change.

Employers, who will bear most of the cost, may look elsewhere to offset those costs, whether that be through limiting pay rises, reduced recruitment or lower levels of business investment. Employees may reduce their pension savings to increase take home pay. Indeed, in its report the Office for Budgetary Responsibility anticipates some behavioural change following the introduction of the policy, projecting that whilst NICs are expected to increase by £4.7bn in 2029/30, this will drop to £2.6bn in 2030/31 due to uncertainties as to how employers and employees will respond.

Significantly, critics also point out that the change further risks member confidence in pensions savings, at a time when we have an ongoing Pensions Commission review into pensions adequacy. 

What this means for employers

The fact that this change will not come into effect until April 2029, with further detail seemingly not an immediate priority, means that employers offering salary sacrifice for pension contributions do not need to take immediate action. As further detail emerges, such employers may need to:

• investigate the increased cost to the business and understand how this will be met, particularly where any employer NIC saving is shared with employees
  
  
• review salary sacrifice documentation and communications sent to employees explaining the change and how it will impact their take-home pay
  
  
• update payroll systems to allow for reporting of the total amount sacrificed to HMRC. Further guidance will be published on this in due course.
  
  
• consider whether flexible benefit arrangements or other benefit arrangements where employees have a choice between cash and pension contributions could be caught by the proposal.

What this means for trustees

Trustees of pension schemes where salary sacrifice is used may, in time, need to:

• review any provisions of their scheme governing documentation relating to salary sacrifice arrangements to check whether any amendments may be required as a result of the Budget announcements or to reflect any changes to the salary sacrifice arrangements proposed by the employer
  
  
• review any member-facing trustee communications (for example on the scheme website) which explain how salary sacrifice arrangements work to ensure these take into account the changes announced and ensure the scheme's administration team are prepared to provide a suitable response to any member queries on this topic
  
  
• be prepared to engage with the scheme employer in relation to any benefit change proposals that may be put forward as a result of the Budget announcements and ensure co-ordination in how these are communicated to members.

PPF and FAS compensation

Members of eligible defined benefit schemes who lost all or part of their pension following the insolvency of their scheme's employer are eligible to receive compensation from the PPF or FAS. The compensation payable is set out in legislation and currently does not provide pension increases on pensions earned by service before 6 April 1997. In light of the PPF's sizable reserve, there had been calls for the Government to amend the terms of the compensation schemes to provide inflationary increases on benefits earned before 1997.

The Budget was light on the detail but confirmed that from 1 January 2027, members of the PPF and FAS will be provided with increases linked to the Consumer Prices Index, capped at 2.5% a year, on benefits earned before April 1997. Crucially, to avoid situations where members receiving compensation might be better off in the PPF than outside it, such increases will only be paid where the governing documentation of the original transferring scheme provided for pre-1997 increases.

The question of whether surpluses should be used to provide members of defined benefit schemes with discretionary pre-1997 increases is one that many schemes are currently grappling with. Limiting pre-1997 increases to PPF schemes whose rules required such increases should not place sponsors and trustees of schemes whose rules provide for discretionary increases under additional pressure to award them. Nevertheless, the question of how scheme surpluses can and should be used remains an important hot topic.