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The Chancellor targeted pension salary sacrifice in the Budget, in a move that will cost millions of workers extra in tax and National Insurance.
A salary sacrifice pension arrangement is when you and your employer agree to reduce your gross salary in exchange for increased pension contributions. It’s a popular way to boost your retirement savings because it can save you and your employer money on tax and National Insurance contributions (NICs).
Here, we explain how salary sacrifice works, what the pros and cons are, and what it could mean for your retirement savings when the rule changes announced in this year’s Budget come into effect in 2029.
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How does salary sacrifice work?
If your employer offers a salary sacrifice pension scheme, you can agree to give up a portion of your salary. Instead of paying that money to you as income, your employer pays it straight into your pension as an employer contribution.
Because the money goes directly into your pension before tax and National Insurance are deducted, you’ll only pay these on your reduced salary, not the full amount. This means you could end up with:
- A higher take-home pay than if you made standard pension contributions from your salary, and
- A larger total pension contribution, depending on whether your employer passes on their own NIC savings.
Helena Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “Salary sacrifice arrangements are particularly valuable for both employers and employees, because by giving up a portion of their salary for pension contributions, employees get the full value of every pound, saving both income tax and National Insurance. Employers, meanwhile, save the National Insurance that would have been payable on that slice of the salary.”
Example: how salary sacrifice can boost your pension
Let’s say you earn £40,000 a year and agree to sacrifice £2,000 of that into your pension.
- You’ll only pay income tax and National Insurance on £38,000.
- Your take-home pay will fall slightly, but you’ll have avoided tax and NICs on the £2,000 sacrificed.
- Your employer also saves NICs and may add those savings to your pension.
So, instead of losing a chunk of that £2,000 to tax and NICs, most or all of it ends up growing in your pension instead.
The tax savings can be particularly useful for those close to key income thresholds. Alice Haine, Personal Finance Analyst at Bestinvest by Evelyn Partners, the online investment platform, explained: “Salary sacrifice schemes can also help keep earnings below key income tax thresholds – important for those facing tax cliff-edges such as the £100,000 earnings threshold, when an individual faces an effective tax rate of more than 60% due to the loss of the personal allowance by £1 for every £2 of income above that level.”
Salary sacrifice can also be a particularly important benefit for basic-rate taxpayers who can save even more than those in the higher tax brackets. Camilla Esmund, senior manager at Interactive Investor, said: “They can save £8 in NI for every £100 they contribute to their pension versus £2 for anyone earning above £50,270.
“Paying this additional take-home pay into your pension can improve your retirement savings by thousands. Someone earning £35,000, contributing 5% of their pay to their workplace pension and directing the £12 monthly NI saving to their pension – either a workplace scheme or a SIPP – could increase their pot by £27,600 over 40 years.”
However, it’s worth noting that while salary sacrifice for pensions can be very tax-efficient, it’s not always ideal for everyone. That’s because when you agree to salary sacrifice, your official gross salary is reduced. This might affect things like mortgage or loan applications as lenders might assess affordability based on your lower contractual salary.
Learn more about salary sacrifice in our article What is salary sacrifice?
How has the Budget targeted salary sacrifice for pension contributions?
The Chancellor has announced plans to cap the amount of your salary that can be sacrificed into a pension without incurring National Insurance payments to £2,000 a year, with effect from April 2029.
According to the government, three-quarters (74%) of basic rate taxpayers won’t be affected by the change, but it will impact those who wish to boost their contributions beyond auto-enrolment minimums and end up exceeding the £2,000 limit. Higher earners will also be affected.
Mark Futcher, Partner and Head of Defined Contribution Pensions at Barnett Waddingham (BW), said: “The Chancellor’s decision to cut salary sacrifice will reverberate across workplaces. While it may raise extra NI revenue, it removes one of the most effective ways people boost their pension savings. With adequacy levels already worryingly low, this change will hit average earners hardest and increase cost pressures for employers at a time when budgets are stretched. It also runs against the aims of the new Pension Commission, which is focused on strengthening long-term saving, not undermining it.
“Sudden tax and insurance changes like these only create a lose-lose scenario for employers and employees – which we’re seeing play out in the employment data across the UK. We can only hope the Government recognises the damage this could cause and turns her attention to policies that make it easier for ordinary working people to build a secure retirement, not harder.”
According to calculations by Lane Clark & Peacock, an individual earning over £40,000 who sacrifices the auto-enrolment minimum of 5% of their salary for pension contributions will exceed the £2,000 cap, which means many moderate earners will also be caught by this change.
Gary Smith, senior partner and retirement specialist at wealth management firm Evelyn Partners, said: “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.”
A final thought
There’s no escaping the fact that by targeting salary sacrifice in this year’s Budget, there will be a cost for both workers and employers.
Mike Ambery, Retirement Savings Director at Standard Life, said: “By limiting the amount of income that can be sacrificed without paying National Insurance, the government will be increasing the cost of pension contributions to both the individual and the company if the level of contributions is maintained. Ultimately, the impact of National Insurance being paid will be felt in employees’ pockets with less take-home pay and in employers’ payrolls with higher costs.”
However, this doesn’t take away from the fact that saving for retirement remains crucial. Even with the salary sacrifice changes, pension saving remains one of the most tax-efficient ways to build long-term security, so it’s worth reviewing your contributions and taking advantage of existing reliefs while they remain. You can learn more about these in our guides How does pension tax relief work? and How do pension allowances work?
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “It’s important to note that contributions will still be exempt from income tax, so it remains a really tax-efficient way to save for retirement.
“It’s also worth saying that the change will not be made until 2029, so there is plenty of time to make the most of the system as it currently stands. If you have some spare cash and you contribute to a salary sacrifice arrangement it could make sense to boost your contributions and make the most of the income tax and National Insurance savings to boost your long-term resilience.”
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If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide Chartered independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial adviser. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 2,600 reviews on VouchedFor, the review site for financial advisers.
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