Budget 2025 - Salary sacrifice cap puts £4.7bn wedge in public-private pension gap

The Chancellor of the Exchequer in her Budget speech today capped the amount of salary that workers can sacrifice into workplace pensions at £2,000 a year from April 2029.

Gary Smith, senior partner and retirement specialist at wealth management firm Evelyn Partners, comments:

‘This cap throws a spanner into the works of private sector pensions, where salary sacrifice is a crucial and valued feature of workplace schemes. At £4.7billion, the tax take is greater than expected and means the impact of this policy on pensions, pay or businesses – or all three – could be severe. Research earlier this year suggested that about 48% of all UK private sector companies offer salary sacrifice pension contribution systems, but at larger firms it was about 67%, and up to 85% for biggest employers.

‘Restricting salary sacrifice is a tax penalty on people trying to the right thing by saving efficiently for their own retirement and it’s yet another National Insurance cost increase imposed on firms, which may result in reduced pay and pension benefits for private sector employees. Some employers who currently pay more than the auto-enrolment minimum on behalf of their employees will be inclined to reduce their contribution rates or other employee benefits to adjust for these changes.

‘Under the current minimum auto-enrolment scheme percentage contribution rates, someone earning less than £40,000 a year will not be affected by these changes.

‘For those who earn more, it will depend on how firms react and how they manage their pension systems. It could be that many white-collar workers will just see their monthly NI bill go up and take-home pay go down if they study their payslip.

‘An individual earning £100k a year could have £393 a year less paid into their pension, if the employer based the contributions on 100% of salary and gave all of the NI saving back to the employee. For someone earning £200k, the figure rises to £708 less being paid into the pension. But if some contributions are done by salary sacrifice, and the rest not – will some firms just switch to a net pay system for instance?

‘As the government recently announced a pensions commission charged with trying to encourage greater private saving, this is a shot in the foot of that project, as it can only discourage workplace saving. And it will certainly be a blow for those who are using salary sacrifice to avoid punitive marginal tax rate steps like that at £100k, and people with variable pay like bonuses who often opt to sacrifice these in lieu of a highly tax efficient pension contribution.

‘But one thing this salary sacrifice crackdown won’t do is earn the Chancellor a backlash from the public sector, as a raid on tax-free cash would have done. It is politically convenient that public sector schemes do not generally operate on a salary sacrifice basis but rather operate as “net pay arrangements”.

‘A cap on employee salary sacrifice for pension contributions should therefore have little impact on the public sector, including all of the civil service and government-backed schemes, which will save this Government another run-in with the unions and vested public sector interests.

‘However, the upshot is that it will put a further wedge in the growing divide between private and public sector pensions. Restricting this sensible tax benefit that makes private sector saving more attractive adds insult to injury in a two-tier pension system where public sector pensions, underwritten by taxpayers, are hugely more generous and reliable than those available in the private sector.

‘It follows hot on the heels of another measure at the last Budget which removed one of the very few perks of holding a defined contribution pension pot – that any unspent assets could be left to loved ones without incurring inheritance tax. That “privilege” will be extinguished from April 2027 so together with today’s news you could be forgiven for thinking that there is a wilful negligence towards private sector pensions - except as a potential cash cow.’