What the 2025 Budget means for pensions

The 2025 Budget included several pensions-related developments. Whilst much of the detail is currently limited (and years away in some cases), it is consider the main headlines and look forward to what 2026 might hold.

Cap on salary sacrifice

Under a pensions salary sacrifice arrangement, an employee agrees to give up (sacrifice) part of their entitlement to salary or bonus in return for an employer contribution to their pension scheme, resulting in a National Insurance saving. This is achieved by varying the individual’s contractual terms and conditions.

From 6 April 2029, the government announced in the Budget that pensions salary sacrifice contributions will be capped at £2,000 a year. Any contributions exceeding that cap will be made subject to employee and employer National Insurance contributions, in the same way as other employee workplace pension contributions. Contributions will remain “exempt from Income Tax (subject to the usual limits),” and presumably any other tax charges if they are within the applicable annual allowance.

The changes are intended to “increase fairness, while protecting ordinary workers” as the “costs of relief through salary sacrifice relate disproportionately to pension contributions from those on higher incomes.” The Government estimates that 74% of basic rate taxpayers using salary sacrifice to make pension contributions will be unaffected by the change.

The changes will be legislated for through primary and secondary legislation which will be introduced in due course. However, initial guidance was published alongside the Budget, and the government intends to publish further guidance before April 2029. Although it is currently unclear exactly how the changes will work in practice, the initial guidance suggests the administrative burden will be placed on employers who will need to report the amounts sacrificed via their existing payroll software. 

It is currently unclear whether the government will also seek to implement measures to prevent employers and employees from renegotiating their contractual terms before the £2,000 cap takes effect. Therefore, it will remain to be seen if these changes will have an impact on levels of pension contributions and individuals’ willingness to save.

Surplus

Under changes being made by the Pension Schemes Bill (PSB), defined benefit (DB) scheme trustees will be given power to amend their scheme rules to pay surplus to sponsoring employers. The government’s original plans for surplus flexibilities also considered the possibility of allowing trustees to pay one-off member lump sums, without baking in long-term liabilities. Such standalone lump sum payments (ie not linked to a pension entitlement) would currently amount to unauthorised payments under the pensions tax rules.

The government has now announced as part of the Budget that, from April 2027, ‘well-funded’ DB schemes will be able to pay surplus funds directly to scheme members who have reached normal minimum pension age (currently age 55 but increasing to age 57 from 6 April 2028 in most cases), where scheme rules and trustees permit it. These changes are to be addressed in the Finance Bill 2026/7 and are due to take effect from 6 April 2027.

For trustees and members, this change will remove another barrier to well-funded schemes sharing surplus with members. From the government’s perspective, it potentially brings forward tax revenues as these payments will be treated as authorised payments and taxed as pension income at the individual’s marginal rate.

This may also make it easier for trustees and employers to reach a deal that allows for DB scheme surplus to be shared between the employer and scheme members.

Pensions and IHT – some concession for personal representatives

Having already confirmed its plans to bring most unused pension funds and death benefits in scope of IHT from 6 April 2027, the government has also announced that PRs will be able to direct pension scheme administrators to withhold 50% of taxable benefits for up to 15 months and to pay IHT due in certain circumstances. PRs will also be discharged from a liability for payment of IHT on pensions discovered after they have received clearance from HMRC.

PPF and FAS indexation

The Chancellor also announced that compensation paid by the Pension Protection Fund (PPF) and the Financial Assistance Scheme (FAS) in respect of benefits accrued before April 1997 will increase in line with Consumer Prices Index (CPI) capped at 2.5% a year where such benefits were provided under the rules of the original pension scheme).

Currently, the PPF only provides increases in compensation (payable annually) in respect of benefits accrued on or after 5 April 1997. This is because there is no statutory obligation to provide inflation increases on benefits accrued before then. 

Amendments to the PSB have been tabled, with the relevant clauses expected to come into effect from January 2027. 

2026 and beyond

Clearly, much of the detail from the Budget announcements remains outstanding, and it is not yet clear how certain key pensions changes will work in practice. Yet looking forward to 2026, we should see the PSB receive Royal Assent. It includes a wide-ranging suite of measures from, on the DB side, provisions to deal with issues arising from the Virgin Media case to giving trustees power to pass a resolution amending their scheme rules allowing greater flexibility over the use of any surplus, subject to “stringent funding safeguards.” For defined contribution (DC), the introduction of guided retirement, automatic consolidation of small pots and the creation of ‘megafund’ default arrangements by 2030. 

The government’s focus on consolidation is likely to continue across both DC and DB spaces with a view to improving governance and DC member outcomes. We may also see further initiatives to encourage investment in UK productive finance with a view to boosting economic growth.

Ultimately, much of the underlying detail remains outstanding. Yet each of these Budget measures will require advisers to monitor emerging legislation closely, particularly the salary sacrifice cap mechanics, trustee rule-amendment powers for surplus, and the new IHT framework for pension death benefits. 

As the PSB progresses towards Royal Assent in 2026, practitioners should prepare for a materially altered regulatory landscape across both DB and DC, with new trustee discretions, evolving funding safeguards, consolidation requirements and a clearer direction of travel toward productive-finance investment. Indeed, the practical implications for scheme governance, employer negotiations, member communications and tax planning will be significant.