Workers face reduced tax perks as limits on pension contributions reshape retirement planning

UK employers are preparing for major changes to salary-sacrifice pension schemes as new rules begin to restrict the tax advantages that workers have relied on for years. The updated framework, announced as part of the latest Budget, limits how much of an employee’s pension contribution can be sheltered from National Insurance through salary sacrifice, raising concerns that many people could see the long-term growth of their pension pots slow down.

Salary sacrifice has been a popular way of boosting retirement savings because employees exchanged part of their salary for employer pension contributions, lowering both income tax and National Insurance deductions. Under the new rules, only the first £2,000 of sacrificed salary per year will remain exempt from National Insurance, reducing one of the biggest incentives behind this method of pension saving.

The impact is expected to fall unevenly across the workforce. Lower earners contributing modest amounts may notice little difference, but those diverting larger sums through salary sacrifice — including mid-to-high earners and employees receiving bonus-linked pension contributions — could face significantly higher NI bills. For employers, the reform increases costs too, and some may adjust benefit structures or reduce pension generosity to manage the change.

Analysts warn that the long-term effect of the reform could be smaller pension balances at retirement unless affected workers take steps to compensate. Reduced tax efficiency could discourage voluntary contributions beyond the statutory minimum, particularly among those already managing rising living costs. Financial advisers say this trend risks undermining retirement outcomes unless alternative saving strategies are adopted.

The shift represents another pressure point in the wider pension landscape. Many households have already seen their disposable income strained by inflation, higher mortgage costs and frozen tax thresholds, with retirement planning slipping down the priority list. Limiting salary sacrifice tax relief could make it even harder for individuals to maintain the level of pension saving required to secure long-term financial security.

Some companies are reviewing whether to introduce additional employer-funded contributions or match top-ups outside the salary-sacrifice structure. Others are focusing on employee education, helping staff understand how their take-home pay and future savings will change once the rules take effect. Transparency is being highlighted as essential to avoid workers unknowingly reducing their retirement prospects.

As the deadline for implementation approaches, financial advisers are urging workers to reassess contribution levels, run updated pension projections and consider complementary savings routes such as ISAs to offset any potential shortfall. With fewer tax advantages available, retirement planning is likely to require closer attention than before.

Although the core auto-enrolment system remains unchanged, the cap on salary sacrifice alters one of the most effective tools for building pensions efficiently. For workers who rely heavily on this route, inaction could mean a notably smaller pot when they reach retirement age.