As announced by Rachel Reeves in the budget, from April 2029 salary-sacrificed pension contributions will only be free from national insurance for the first £2,000 a year.
Any amount above that £2,000 will be treated as ordinary employee pension contributions in the tax system, meaning both you and your employer will have to pay national insurance on them, and your tax bill will go up.
National insurance is charged at 8% on earnings less than £50,270 and 2% on income above that, and 15% for employers.
Who will be affected – and what should you be doing now to make the most of your money?
Around 7.7 million people are estimated to use salary sacrifice to pay into a pension – that’s around 20% of the workforce.
The Treasury has said many people will not be affected by the measure because it is aimed at higher earners.
“The cap means 74% of basic rate taxpayers, and their employers, currently using salary sacrifice will be unaffected by this change,” it said.
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For a person earning £40,000 a year, making a typical minimum 5% contribution into their pension, there would be no further tax to pay as they would just reach the £2,000 threshold.
(You can contribute less than 5%, but your employer would have to make up enough to take the total minimum salary sacrificed to 8% – it is typically split as 5% employee and 3% employer.)
If the employee earning £40,000 were to increase their contribution from 5% to 6%, they would breach the new £2,000 cap by £400 and their tax bill will rise by £32.
Someone earning £50,270 (the maximum for a basic rate taxpayer) and making the minimum 5% contribution into their pension would breach the cap by £513.50, pushing their NI bill up by £41.08.
But if they were to earn £1 more and become a higher rate taxpayer, their bill would only increase by £10.27 because they would be charged a 2% NI rate.
A person earning £105,000 a year, sacrificing £10,000 to keep hold of tax perks, would have to pay national insurance on £8,000.
Because they are a higher rate taxpayer, the national insurance would be charged at 2%, meaning they would pay £160 extra in NI.
“There’s a danger that the biggest increase in deductions due to NI becoming payable (in % terms) are faced by people just under the £50,270 threshold,” said Charlene Young, savings and pensions expert at AJ Bell.
“Employers will be hit with a straight 15% NI charge on the excess, meaning the higher the earner, the higher the potential hit for them.”
So what should you do now to make the most of your money?
Several financial planners have told savers to use salary sacrifice to top up their pension while they can.
Eamonn Prendergast, a chartered financial adviser at Palantir Financial Planning, told Money that employees should maximise their contributions before the cap comes into place.
“People should review their pension strategy, use available allowances while they last, and plan for life after 2029 by building flexibility into their savings,” he said.
Scott Gallacher, the director of financial services firm Rowley Turton, said employees should start building pension planning into annual pay rise discussions.
“Instead of giving a full salary increase, employers can direct part of the rise into higher employer pension contributions. This isn’t salary sacrifice in the traditional sense, but it achieves a similar outcome and is more likely to remain outside future restrictions,” he explained.
“Planning pay and benefits in this way over the next few years should help employees maintain tax-efficient pension funding long after the new cap takes effect. The key is to start planning now, before it becomes a problem.”
Anita Wright, a chartered financial planner at Ribble Wealth Management, wasn’t as optimistic, pointing out that many people were struggling to keep up with the cost of living and couldn’t afford to “load up” salary sacrifice contributions before the cap.
“Many simply do not have the spare monthly cash to sacrifice more of their pay now in order to mitigate a future rule change,” she told Money.
“In practical terms, that means there is not a great deal of meaningful personal planning most people can do beyond the usual basics: maintaining affordable contributions and reviewing pensions.”
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What do you need to be aware of?
Although savers will be tempted to sacrifice as much as they can into their pension, Young warned that there are some key things to bear in mind.
“Firstly, pension salary sacrifice is a formal arrangement to exchange pay for a pension contribution and it lowers your salary on paper. A lower salary can affect other areas of your personal finances, such as eligibility for a mortgage,” she said.
“You also cannot sacrifice salary to the level that it will bring your earnings below the national minimum wage rate.
“There’s also a danger you could box yourself in when you might want access to the cash you’ve given up. This is because employers offering salary sacrifice will usually only allow changes once a year or another set intervals.
“Many use the anniversary of the pension scheme or the company business year, only allowing other variations on certain life events outside of this.”
What about after the cap?
“Whatever you do, don’t stop your pension contributions” – that is Young’s advice.
If you can help it, try not to reduce them either, she said.
“Despite the NI savings being capped, what you pay into pension will still be exempt from income tax, and in turn reduce your taxable income,” she said.
“This is important as it can pull you out of higher rate taxes or one of the many punishing tax traps while also boosting your retirement savings. Pensions contributions are your best weapon against the continue freeze of frozen allowances.”
She added that people not in salary sacrifice schemes would continue to get tax relief too – it will just come with a little extra life admin.
“Instead of making a formal arrangement to keep their salary below a certain level, they can work out what level of contributions they would to reduce their ‘adjusted net income’. This will involve a little bit of extra admin but will still be well worth it when you consider the potential income tax savings on offer,” she said.
Prendergast agreed and pointed out that many employers would still match contributions after the introduction of the cap.
“Despite the changes, pensions remain one of the most tax-efficient and powerful long-term investments and the cornerstone of any serious financial plan,” he said.
