What pension changes is Rachel Reeves considering in the budget? | Budget 2025

What is salary sacrifice?

Pay sacrifice has long been linked to initiatives such as the government-backed work transition scheme (it is also said to be on the chancellor’s mind). However, an increasing number of companies are offering pension sacrifice as a bonus, and this can be a very tax-efficient way to save money in your workplace plan.

This involves an employee agreeing to give up some of their salary and transfer the amount they would otherwise receive to a “non-cash” benefit (in this case, extra employer contributions to the pension pot).

These schemes can run alongside traditional workplace pension contributions; If your employer allows you to make an “additional voluntary contribution” this may be through salary sacrifice.

The money you sacrifice comes from your gross salary – your pay before income tax and national insurance (NI) is deducted – so making a contribution costs less than if it were made from taxed income.

By reducing your salary you also reduce the amount you pay in NI. This means your take-home pay may be higher than if you paid the same amount into your pension under a traditional arrangement.

There may be another advantage to reducing your taxed earnings; If you’re a parent and earn more than £60,000, you can transfer the money into your pension and keep more of the child benefit you claim.

These plans also benefit employers because they do not have to pay NI to employees on the money sacrificed. Some will also pay some or all of their NI savings into the worker’s pension, increasing their earnings even further.

What is thought?

The government is reportedly seeking to restrict the tax benefits offered by these plans, amid suggestions that many high-income earners are maximizing the benefit.

“Instead of a complete ban on salary sacrifice, one option on the table is to impose a £2,000 cap on the amount of earnings that can be exchanged for pension contributions that benefit from the national insurance exemption,” says Charlene Young of investment platform AJ Bell.

What would be the effect?

It has been reported that introducing this cap could cost up to £2bn a year, but this comes at a cost to workers and companies. AJ Bell said someone earning £55,000 a year and contributing 10% (£5,500) to their pension through salary sacrifice would have £188 a year cut from their take-home pay and their employer would pay an extra £525 in NI. If salary sacrifice is removed as an option, the figures will rise to £441 and £825 respectively.

Pension experts warned We believe that cutting savings incentives at a time when there are concerns about the adequacy of people’s retirement planning would be counterproductive.

on thursday, Aviva CEO Amanda Blanc told the Times:: “What you are effectively doing is penalizing employers who contribute more to employees’ pensions.

“But you’re also telling people who are saving for their pensions that they shouldn’t be doing that, and I think that’s bad news for the UK in the long run if you think about the fact that 15 million people in the UK aren’t saving enough.”

Is pension tax-free cash safe?

Currently, from age 55 (57 from April 2028) you can usually receive 25% of your pension as a tax-free lump sum, up to a limit of £268,275.

Going back a few weeks, there was feverish speculation that Reeves might try to lower that limit. However, in the last few days, news has emerged claiming that the Treasury has rejected such a move for now.

Helen Morrissey, of investment platform Hargreaves Lansdown, says: “Tax-free cash restrictions are reported to be firmly off the table. It’s a move that will be greeted with great relief by people who have worked hard to create a decent retirement income and are worried about the impending loss of a valuable benefit.”

What about retirement tax relief?

In simple terms, when someone pays into a pension, the government usually adds a top-up payment called a tax deduction. This means their savings are often increased by 20% or more, depending on income tax rates; so people who pay 40% or 45% tax receive extra relief (different rates apply in Scotland). All in all, this is an extremely valuable tax break and is a big part of why saving into a pension is generally seen as a very good thing for people to do.

There are rumors almost every year that the government will tighten pension tax relief in order to make the system less generous to the better off. This is no surprise when you consider that pension contributions tax relief costs the government anywhere from £50bn to £60bn a year, depending on whose figures you believe.

At the time of writing, cutting/redistributing pension tax relief is not seen as a precursor to this month’s budget.