Chancellor caps pension salary sacrifice and provides pre-97 increases for PPF members

In a surprise move, the Chancellor has also announced a range of other measures – including providing pre-97 pension increases on compensation payable from the Pension Protection Fund (PPF) and the Financial Assistance Scheme (FAS), and a proposal that from 2027 well-funded DB pension schemes will be able to pay surplus funds directly to certain members if scheme rules and trustees permit it.

Many members will breathe a sigh of relief that some of the broader potential changes (such as caps on tax free cash) did not make it into the Budget. However, the changes announced could have knock on consequences, such as reducing the amount people pay into their pension in future; at a time when the Government and industry are trying to encourage people to save more for their retirement. It also raises questions over what more there is to come as the Pension Schemes Bill continues its journey through Parliament and whether the related calls for mandatory pre-97 pension increases to be provided by defined benefit schemes more generally, could become a reality, although there is no suggestion of this in the Budget. 

What is salary sacrifice?

Salary sacrifice is a feature of many workplace pension schemes in the UK. In this context, salary sacrifice involves an employee giving up the right to part of their salary in return for higher pension contributions from their employer. This is achieved by varying the employee’s terms and conditions of employment. An employee may also sacrifice a one-off payment such as a bonus where employers permit this. 

Where salary sacrifice is used, both the employer and employee benefit from a reduction in their national insurance contributions (NICs). This is because an employee’s salary is subject to employer and employee NICs, whereas employer pension contributions are not. Therefore, both parties benefit where salary is sacrificed in exchange for higher employer contributions.

What’s changing?

From April 2029, the amount that is exempt from NICs will be capped at £2,000 a year for employee pension contributions made using salary sacrifice. Contributions made through salary sacrifice arrangements above this amount will be subject to employer and employee NICs like other employee workplace pension contributions.

Contributions made through salary sacrifice, like all pension contributions, will still be exempt from income tax (subject to the annual allowance, which is not changing).

Practical implications

Based on current rates of NICs, the cap on salary sacrifice will mean:

• employers will have to pay 15% NICs on amounts sacrificed above the new cap, and
• most employees will have to pay extra NICs on these amounts too (at either 8% or 2% depending on the amount of their salary)

Pre-97 pension increases from the PPF and FAS

In a surprise move, the government also announced it will modify the rules relating to compensation payable to members whose schemes have entered the PPF or FAS. This will see members receive CPI-linked increases, capped at 2.5% a year, on pension benefits built up before 6 April 1997, from January 2027, where such increases were provided by their former scheme. This will clearly benefit members whose former schemes provided pre-97 increases but may not provide full compensation for the increases they would have received under that scheme.

This is a significant change, announced without consultation. Not only will it impact the PPF’s available surplus, it could also change the dynamics of the wider ongoing debate over the extent to which increases on pre-97 pensions should be provided by defined benefit schemes more generally. This is normally a matter for agreement between trustees and employers, but some MPs are calling for this to be mandated in the Pension Schemes Bill that is currently going through Parliament.

Other pensions-related announcements

• announced that the government will enable well-funded DB pension schemes to pay surplus funds directly to scheme members over normal minimum pension age, where scheme rules and trustees permit it, from April 2027 - depending on the rules that surround this, this could prove to be an efficient way to distribute surplus funds to members where sponsors and trustees decide to do this. However, the fact this will not come in until 2027 could hold up discussions over the use of surplus assets in advance of this
• confirmed that the government will bring unused pensions and death benefits into the inheritance tax regime from 6 April 2027 – in a change from the revised proposals published in July 2025, the Budget documents indicate that personal representatives will be able to direct pension schemes to withhold 50% of taxable benefits for up to 15 months and pay any Inheritance Tax due in certain circumstances before releasing the rest of the benefits to the pension beneficiaries. Personal representatives will also be discharged from a liability for payment of Inheritance Tax on pensions discovered after they have received clearance from HMRC. The final legislation is due to be set out in the Finance Bill 2025-26, which is due to be published shortly
• reaffirmed the government’s commitment to the state pension triple lock for the remainder of this Parliament – this will see the State Pension rise by 4.8%, to over £12,500 on 6 April 2026
• announced that income tax thresholds will be frozen at current levels for a further three years beyond 2028-29 - this would mean individuals who are only in receipt of the state pension could be forced to pay income tax, although the Chancellor said they would introduce measures to ease the administrative burden for pensioners whose sole income is the basic or new State Pension without any increments so that they do not have to pay small amounts of tax via Simple Assessment from 2027-28 if the new or basic State Pension exceeds the Personal Allowance from that point. The government has said it is exploring the best way to achieve this and it will set out more detail next year
• the annual limit on the amount that can be saved into cash ISAs will be cut to £12,000 for people under age 65 from April 2027 to encourage individuals to save more in stocks and shares ISAs – this is part of the government’s drive to encourage more investment in UK productive assets