Pensions UK’s executive director of policy and advocacy Zoe Alexander issues a stark warning on the salary sacrifice cap and its impact on retirement saving, following recent analysis from the Office for Budget Responsibility.
The government’s proposed reforms to salary sacrifice may have been trailed as a targeted measure aimed at high earners, but the latest analysis from the Office for Budget Responsibility (OBR) suggests its impact will be far broader and far more disruptive than the official narrative admits, with workers paying the price.
While the government’s initial messaging argued 56%, or around 4.3 million people, would be fully protected by the £2,000 threshold, the modelling tells a different story: one of widespread behavioural change, rising administrative complexity, and ultimately lower retirement incomes for millions of people at a time when adequacy is already a major industry concern.
The government’s initial assessment was focused only on the direct impact, ignoring the reality that employers and workers will take action to mitigate the proposals.
Member behaviour expected to change, and not for the better
Indeed, a survey of Pensions UK members ahead of the change in policy revealed that three-quarters of respondents believed savers were likely or very likely to alter retirement contributions or decisions if the reforms went ahead.
Although some had hoped for at least a temporary influx in pension saving ahead of the changes, the OBR’s modelling reveals that very few are expected to take advantage. In fact, many are more likely to divert contributions away from their pension to receive an increase in take-home pay once the changes hit.
The OBR also assumes that 80% of affected members in defined contribution (DC) schemes will adjust their contributions to offset reductions in take-home pay. Higher earners are expected to reduce contributions by 1.8%, with lower earners cutting by 2.75%.
This doesn’t simply shift tax liability; it erodes long-term savings. In an adequacy environment that is already precarious, even small reductions in contribution rates have disproportionately large retirement income consequences. Lower earners, who already struggle to contribute at meaningful levels, are likely to be hit hardest.
But the bigger concern is the response from employers, which could put many of those previously thought to be shielded at risk of a pass-through impact as a result of the changes.
Low incomes, different lives: The unequal reality of low earners
The Pension Policy Institute’s John Upton explains that low earners cannot be treated as one homogenous group, as the Pensions Commission and others seek to improve retirement savings adequacy. Read the full article.
Employers will have to change their approach – and members will feel it
At the Budget, the government highlighted that 7.7 million employees currently use salary sacrifice for pension contributions, with 56% – around 4.3 million people – apparently ‘protected’ because they sacrifice less than the proposed £2,000 annual threshold. But the OBR’s breakdown makes clear that many of those supposedly unaffected workers will, in practice, lose out depending on how employers respond.
The OBR identifies several likely employer behaviours, each with significant implications.
The first is a shift away from salary sacrifice altogether, replaced with ordinary employer pension contributions. But this comes with a major trade-off: workers could see slower wage growth, or even reductions in their contractual salaries, as employers attempt to neutralise their own rising National Insurance costs.
Existing rules would also force employers to apply changes across the workforce, not selectively, making abrupt, large-scale payroll adjustments more likely.
Even more concerning, the OBR expects 76% of employer costs to be passed on to workers, either through slower pay progression or lower employer contributions. In other words, costs that employers can no longer avoid will quietly filter through to members’ take-home pay and retirement savings.
The move away from salary sacrifice could push many workers into relief-at-source (RAS) arrangements instead. While this may sound like a benign administrative shift, the OBR notes that around 10% of higher-rate and additional-rate taxpayers fail to reclaim top-up relief under RAS.
If workers move from a system where relief is delivered automatically via salary sacrifice to one requiring action and understanding, unclaimed entitlements will rise – and retirement savings will fall.
A policy with more questions than answers
Beyond adequacy, the reforms create a series of practical complications. Student loan interactions, for example, are already causing confusion. HMRC’s insistence that its reforms protect 95% of workers under £30,000 does little to address the administrative complexity facing employers who must recalculate thresholds, contributions, and repayment schedules.
“With public finances under strain and adequacy pressures intensifying, the UK cannot afford a policy experiment that results in millions of people saving less for retirement.”
Zoe Alexander, Pensions UK
Salary sacrifice has always interacted awkwardly with other systems, but introducing a cap – rather than removing or adjusting the structure – magnifies these issues.
Even the OBR acknowledges that forecasting behaviour is uncertain. Forestalling effects are expected to be minimal, not because savers are unconcerned, but because many are already contributing as much as they can afford or as much as the system allows.
This again underscores the central point: adequacy is strained, contributions are tight, and extra friction will push them down further.
The sector must make its voice heard
Much of the modelling shared by the OBR isn’t new, and industry warnings in this area are nothing new either.
Pensions UK previously wrote to the government to express concern in exactly these areas, warning that further changes could not only weaken the foundations of the pensions system but also increase costs for employers and undermine the wider environment for growth, and create further administrative strain on an already heavily burdened industry.
For pensions providers, schemes and employers, the message is clear: the government has considerably understated the scale of disruption that a salary sacrifice cap will trigger. The modelling shows this is not a niche issue affecting a small cluster of high earners; it is a whole-workforce challenge involving payroll systems, HR policies, contribution structures, tax reclaim processes, and ultimately member outcomes.
With public finances under strain and adequacy pressures intensifying, the UK cannot afford a policy experiment that results in millions of people saving less for retirement.
Zoe Alexander is executive director of policy and advocacy at Pensions UK.
