2025 Budget: Focus on Pensions
The Chancellor’s Budget introduced a significant change to workplace pensions, with National Insurance (‘NI’) relief on salary sacrifice pension contributions to be capped at £2,000 per year from April 2029. This measure could have far-reaching consequences for employees, employers and the pensions sector.
What’s changing?
The NI savings that make salary sacrifice so tax-effective for both workers and businesses will be restricted. Employees and employers will only receive NI relief on the first £2,000 of salary sacrificed each year. Contributions above £2,000 will still go into pensions, but without the NI saving advantage.
All employee contributions made via salary sacrifice will continue to reduce the employee’s adjusted net income and so can help restore benefits and allowances such as child benefit and the personal allowance.
However, if the removal of the NI cost incentive causes employees to reduce the amount of salary sacrificed, or opt out then, as well as impacting retirement savings, it could also hit those utilising salary sacrifice to manage the £100,000 - £125,140 tax trap. This can result in an effective marginal tax rate of up to 60%. It could also impact parents seeking to maintain access to childcare benefits by lowering their income via pension salary sacrifice.
Impact on employees
For those on lower earnings, the change may have little effect, as contributions under auto-enrolment minimums typically fall within the cap. Higher earners, however, will see reduced efficiency when sacrificing bonuses or variable pay.
This could make pension saving less attractive and increase take-home tax costs, but as with any long-term investment, the compound impact of this could be significantly larger when missed potential future investment returns are considered.
Public sector schemes do not generally operate on a salary sacrifice basis but rather 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.
Impact on employers
The cap on NI relief doesn’t just affect employees, it also hits businesses. Salary sacrifice has been a cost-saving mechanism for employers because reducing gross pay lowers their NI liability. In many cases, employers will even arrange to contribute some of their own NI savings as an additional pension contribution to employees who salary sacrifice to encourage the strategy and reduce costs across the board.
By capping relief at £2,000 per employee, the government removes much of that incentive. For firms with large workforces or generous pension schemes, this could mean a significant increase in NI costs.
For companies that currently share NI savings with staff, the change could also affect employee morale and retention, as workers see less benefit from sacrificing salary. In sectors where salary sacrifice is widely used, such as professional services and large corporates, the impact could be substantial.
While it is too early to know what the impact of these changes might be, we could see employers who currently offer salary sacrifice consider running a ‘two-tier’ system for salary sacrifice. This could see companies offer salary sacrifice scheme up to £2,000 and then run a ‘relief at source’ or ‘net pay arrangement’ scheme for amounts above.
Whilst higher paid employees are restricted on their pension contributions due to the Annual Allowance tapering, these measures will therefore hit middle income earners who already bear the brunt of a high tax burden.
What hasn’t changed?
Another Budget and another year of considerable pre-budget speculation. Last year Pension providers reported a significant rise in tax tax-free cash withdrawals ahead of the budget and this year was no different. We published our own thoughts on this ahead of the budget and again there were no such changes announced.
Annual Allowance
No changes were announced to the various Annual Allowances for 2026/27
Annual Allowance remains £60,000.
Money Purchase Annual Allowance remains £10,000 with no carry forward.
For the Tapered Annual Allowance, the Threshold Income limit remains £200,000, the Adjusted £260,000 and the minimum allowance remains £10,000.
Lump Sum Allowance and Lump Sum and Death Benefit Allowance
Lump Sum Allowance (LSA) remains at £268,275 – this covers tax free cash payments during your lifetime
Lump Sum and Death Benefit Allowance (LSDBA) remains at £1,073,100 - this covers the totality of lifetime tax free cash, severe ill health lump sums and tax-free death benefit lump sums on death under age 75.
IHT on unused pension funds
As announced in last year’s Budget, from 6 April 2027 most unused pension funds will form part of the member’s estate. Today’s Budget announced a change to the administration of this to ease the burden and liability on personal representatives.
The government are going to allow the personal representatives (PRs) to instruct pension scheme administrators to withhold 50% of taxable pension death benefits for up to 15 months. This is to ensure there is sufficient money available to meet the IHT liability applicable to that pension scheme. Pension beneficiaries will only be able to access 50% of the amount they inherit where the PRs have instructed the scheme.
PRs will also not be liable for IHT due on any pensions which come to light after the administration of the estate has been completed. The pension beneficiary will continue to be liable for any IHT on pension discovered after the PRs have been discharged.
At present the legislation is still in draft form and we will provide further explanation once the Legislation hits the statue books.
State Pensions
The triple lock on State Pensions will be retained for the remainder of this parliament, guaranteeing a 4.8% earnings-based increase in April 2026.
This means that the full New State Pension will increase to £241.30 a week and the full Basic State Pension will increase to £184.90 a week (single person) or £295.70 a week (married couples and civil partners).
With State pensions for some pensioners likely to exceed the Personal Allowance (PA) from April 2027 due to the triple lock and the freezing of the PA, the government is exploring how best to ensure that pensioners, whose only income is the Basic or New State Pension, don't have to pay small amounts of tax via Simple Assessment.
PPF and FAS increases
Currently, any compensation in payment from either the Pension Protection Fund (PPF) or the Financial Assistance Scheme (FAS) in respect of pensionable service on or after 6 April 1997 is increased each year in line with CPI (up to 2.5%).
From January 2027, these increases will be extended to include any amount in respect of pre-6 April 1997 service where the original scheme provided this benefit.