Salary sacrifice cap threatens pension saving

LCP has warned that more than 2.8 million workers are expected to reduce pension saving once new restrictions on salary sacrifice come into force in 2029, according to figures obtained through a Freedom of Information request to HMRC.

The FOI request, submitted by LCP partner and former pensions minister Steve Webb, relates to the government’s planned £2,000 cap on the amount of employee pension contribution that can be paid through salary sacrifice while avoiding employee and employer National Insurance contributions. The change is due to take effect in April 2029.

LCP said the final HMRC response shows that 2.22 million employees earning above the upper earnings limit are expected to reduce contributions in 2029/30. A further 666,000 employees earning between the personal allowance and the upper earnings limit are also expected to cut back.

The upper earnings limit is currently £50,270 a year. LCP said most employees above that threshold are likely to be higher-rate taxpayers, while the 666,000 workers below it will generally be basic-rate taxpayers. The consultancy also pointed to previous Office for Budget Responsibility analysis suggesting lower earners are likely to reduce contributions by the largest amounts.

The FOI figures follow the Pensions Commission’s warning that around 15 million people of working age are already under-saving for retirement. The commission’s interim report, published in May, set out the scale of the challenge facing the UK pensions system and will inform final recommendations expected in 2027.

Salary sacrifice has become a significant part of workplace pension and reward design. Employees give up part of their salary in exchange for employer pension contributions, reducing National Insurance liabilities. Employers can also save National Insurance and may pass some of that saving back into pensions, benefits, or wider reward packages.

The planned cap would not end salary sacrifice pension saving, but it would limit the amount that can attract the current National Insurance advantage. Employees contributing more than £2,000 a year through the arrangement could see a weaker incentive to maintain current contribution levels. Employers may need to revisit reward design, payroll systems, pension communications, and total compensation planning.

The reform creates a difficult policy backdrop. The government is reviewing how to improve retirement outcomes through the Pensions Commission, while a separate tax change is expected to reduce saving among millions of workers. Scrutiny from pensions providers, employers, payroll specialists, and employee benefit advisers is likely to increase as implementation approaches.

The task is not simply technical compliance. Salary sacrifice sits inside wider reward architecture, and changes to take-home pay can affect employee behaviour quickly. Workers who reduce pension contributions to protect monthly income may create a longer-term adequacy problem across the workforce. That risk is sharper where employees already save at minimum auto-enrolment levels or where cost-of-living pressure has limited voluntary increases.

Communication will need to be handled carefully. Salary sacrifice is often poorly understood, even by employees who use it. A cap that changes National Insurance treatment could be interpreted as a pension cut, a tax rise, or a payroll adjustment depending on how it is explained. Clear modelling will be needed to show the effect on take-home pay, pension contributions, employer contributions, and long-term savings outcomes.

The change also lands in a tighter reward market. Employers have increasingly used pensions, flexible benefits, and salary sacrifice as part of total reward while salary budgets remain constrained. If the relative value of pension salary sacrifice falls, pressure may grow to adjust other benefits or explain why overall reward has become less attractive. That could prove harder in sectors already dealing with skills shortages and rising employment costs.

The distributional question may become politically important. LCP’s figures indicate that nearly one in four of those expected to cut pension saving are basic-rate taxpayers. That complicates any argument that the change only affects higher earners and raises questions about the risk to workers already more exposed to inadequate retirement income.

The reform is not due until 2029, although the preparation window is shorter than it appears. Pension scheme design, payroll software, employee communications, and reward strategy all operate on long lead times. Once workers lose confidence in the value of saving, rebuilding contribution levels can take considerably longer.