The tax efficiency of workplace pensions 

In the Budget on 26 November 2025, the Chancellor announced changes to salary sacrifice arrangements, from April 2029, whereby there will be an annual threshold for pensions salary sacrifice of £2,000, above which National Insurance will be payable.

For employers and employees, the changes to salary exchange are still some years off and the opportunities for making tax efficient savings now and in the coming years remain.  And even when the salary sacrifice changes are introduced, pensions will still represent a valuable way of saving cost for employers and employees.  And in the meantime, there is time to plan for the changes.

Pensions are one of the most tax-efficient vehicles for retirement saving in the UK. Contributions benefit from tax relief, investment growth is tax-free, and a portion of pension savings can be withdrawn without tax in retirement. The system was built this way to encourage long-term saving, so it’s important that both employers and employees understand how to get the most out of it.

There are ways to improve the tax-efficiency of a workplace pension for both employer and employee. We explore some of these below. 

According to Mercer’s latest DC MOT research, more than three-quarters (78%) of employers already use salary sacrifice, which improves the tax-efficiency of offering a workplace pension. Under this arrangement, an employee’s salary is reduced, and the reduction is diverted directly to their pension. Because this amount is no longer subject to National Insurance Contributions (NIC), both employers and employees can make meaningful savings: employers can cut costs by up to 15%, while employees may save around 8%.

Salary sacrifice is often one of the simplest ways to make workplace pensions more tax efficient. For employers, it can reduce overall NIC liabilities and help offset the rising cost of benefits – which may be particularly attractive since the employer NIC rate was hiked at the last budget. For employees, it means a higher net pension contribution without lowering take-home pay.

Despite the benefits, it’s not always straightforward. Careful planning is needed to stay compliant with HMRC rules and employment law. Employers must ensure that salary reductions don’t take employees below the National Minimum Wage, and that other salary-linked benefits aren’t inadvertently affected. And of course there are changes proposed for April 2029 that will require planning for.

Still, when implemented carefully, salary sacrifice has been one of the most effective and legitimate tools for improving pension tax efficiency – and will continue to be. 

Another source of confusion is the tax treatment of contributions under different types of defined contribution (DC) schemes.

Under “relief at source” arrangements, employee pension contributions are made after income tax and NIC are deducted. The scheme adds 20% -- equivalent to basic rate tax – to members’ pots. This works well for basic rate taxpayers, but higher rate payers need to claim their full tax-relief in their tax returns.

By contrast, in “net pay” schemes, employee pension contributions are deducted before income tax but after NIC are deducted – meaning employees automatically get full tax relief. However, this means non-taxpayers don’t benefit from the 20% top-up available with relief at source. 

Mercer’s DC MOT research also found that half of employers (50%) provide no support to help employees make informed tax decisions about their pensions, leaving them to navigate complex rules alone. Another 35% offer some guidance, but only 6% go as far as providing employer-funded independent financial advice.

This gap in financial education can be costly. Take the above example of relief at source arrangements: many higher-rate and additional-rate taxpayers do not realise they need to reclaim their full tax relief, or simply forget to do so, and so miss out.

Employers can add real value by helping employees understand how their pension scheme operates and where they might be missing out. Even simple communication campaigns or signposting to high-quality guidance can make a difference.

In light of the announcements in the Chancellor’s 2025 Budget, there is a role for “myth busting” communication for members, as we have seen the news on salary sacrifice misinterpreted by some savers as meaning broader tax relief is changing, which it is not.

Changes to introduce a cap on pensions’ salary sacrifice have been announced from April 2029.  However, pensions continue to be one of the most generous tax breaks available to both savers and businesses – and for good reason, since healthy pension pots benefit not just individuals but the UK economy at large. Yet our DC MOT findings suggest that many organisations – and their employees – are not making full use of what’s on offer. 

By reviewing scheme design, clarifying whether contributions operate under net pay or relief at source, and supporting employees with clear information and advice, employers can help staff unlock significant savings. At the same time, employers themselves can reduce costs and strengthen the value of their benefits package.

Tax efficiency may be the starting point, but the broader outcome is a more financially confident workforce that is better prepared for retirement. 

Mercer’s DC MOT is an audit of your company’s pension practices. It benchmarks your scheme and broader benefits package against those of other UK employers, and against Mercer’s view of best practice.

The results will help you understand how you stand compared to your peers, as well as how your business can save money, increase value and reduce risk in your benefits offering.

Learn more here or speak with your Mercer consultant.