Budget 2025. Pay rises, reward and salary sacrifice: navigating fiscal drag

For UK employers, the 2025 Autumn Budget turned salary into a blunter instrument for rewarding people. Frozen thresholds, fiscal drag and the proposed NIC cap on pension salary sacrifice now mean that each additional £1 of salary delivers materially less net value to employees than it did even two years ago.

To put it bluntly, over the rest of this decade, salary will become one of the least tax-efficient levers in the reward toolkit, whilst pensions and equity incentives have the potential to become even more more attractive.

You can't change the tax system from HR or Finance, but you can decide how much of your total reward budget you route through the most tax-dense channels. Two employers facing exactly the same tax rules - and spending the same on people overall - can deliver very different net outcomes for employees, simply by how they balance salary, pension contributions, salary sacrifice and equity incentives. 

This is why it is worth first pausing on one uncomfortable truth: what £1 of extra salary actually delivers today.

The £1 problem

In the current tax environment, for a typical UK higher-rate employee, £1 of extra salary now delivers around 53p-60p in take-home pay.

For someone in the £100k–£125k taper zone, £1 can deliver as little as 38p.

And from April 2029, every £1 of pension salary sacrifice above the new £2,000 cap will trigger 15p of employer NICs and from 2p to 8p for mid-earners, depending on where the sacrifice falls in the NIC bands.

For HR and Reward teams, this is the real issue: the gap between what employers spend and what employees actually receive is widening - and accelerating - fast. This makes reward design harder, especially when trying to balance pension funding, salary competitiveness and fairness across income bands.

Salary in a tax-rich environment

Because allowances and thresholds continue to be frozen, modest nominal salary increases do more for HM Treasury than they do for employees. The OBR estimates that the cumulative effect of freezing allowances and thresholds will push the proportion of taxpayers in the higher or additional rates from 15% (2021/22) to around 24% by 2030/31.

Translated into Reward language:

• The headline salary percentage increase may look fine in pay review letters and spreadsheets.
• But, the net impact will feel anaemic in employees’ payslips, particularly around key thresholds.
• Meaning, pay compression at the various tax thresholds will intensify, even where organisations believe they are awarding “balanced” pay rises.

In short, progression through pay ranges becomes harder to maintain because the tax system neutralises the differential.

And that's before you take into account the proposed salary sacrifice changes. 

The £2,000 salary sacrifice cap - why it matters

From 6 April 2029, NIC relief on pension salary sacrifice will be capped at £2,000 per employee per year. 

Anything above that threshold will be treated as normal pay for NIC purposes:

• Employee NICs: 8% in the main band (2% above the upper earnings limit)
• Employer NICs: 15%
• Income tax relief: unchanged

The Treasury expects this change to raise £4.7bn in extra NICs in 2029/30. Industry modelling and the government’s own analysis, assumes most of that cost will hit employees through lower take-home pay or reduced pension contributions, rather than being fully absorbed by employers.

Worked example: the reward impact

Employee earning £60,000 sacrificing 10% (£6,000) into their pension.

Today (pre-April 2029): 

• No NICs on the £6,000.
• Both employer and employee retain the full NIC saving.

From April 2029:

• The first £2,000 of sacrifice is still NIC free.
• But the remaining £4,000 treated like normal pay for NICs.
• Extra NIC costs per year:
  • Employee NICs: £4,000 x 2% = £80.
  • Employer NICs: £4,000 x 15% = £600.

That’s £680 a year of additional NIC friction on what is currently one of the cleanest net-of-tax reward tools in the system.

The real sting though is behavioural. Many employers share some or all of their NIC saving with staff through “NIC recycling”. Once the cap bites, the ability to recycle meaningfully above £2,000 of sacrifice shrinks fast.

Salary's shifting role in reward

Put all this together and salary starts to look very different as a reward lever over the rest of this decade. A “good” 4-5% pay rise delivers much less net gain when more of the increase falls into the higher marginal bands. 

Put more starkly, someone currently earning £150,000 earns five times as much as someone on £30,000, yet they pay around 12 times more in combined income tax and NICs.

And this isn’t just a theory, the same dynamic plays out in public sector pay, where long-term fiscal drag has eroded relative positioning.

In 2008, a teacher started on £20,627 which was some 85% higher than the national minimum wage. Today, they start on £32,916, which is only 33% higher. 

For HR and Reward, arguably the strategic question is no longer “What is our average pay rise?”, but “How do we deploy a constrained, heavily taxed salary pot for maximum net value?”

Practical priorities for Reward and HR

Re-baseline what “good” looks like on pay

• Anchor your salary planning in the OBR’s nominal earnings path, which shows pay growth easing back from current 4-5% levels towards the mid-3% range later in the decade.
• Prioritise internal fairness, pay compression and range integrity over headline percentages.
• Target scare budget resource where it genuinely shifts risk.

Treat salary sacrifice as a reward design project, not a payroll tweak

On the journey to 2029, you should:

• Map exposure: who uses salary sacrifice, at what levels and in which business units.
• Quantify impact: model extra NICs at individual and aggregate levels, alongside any NIC recycling promises.
• Decide your salary sacrifice approach:
  • Absorb the NIC hit and preserve existing pension outcomes?
  • Hold employer costs constant and reduce uplift above the cap?
  • Rebalance towards other elements (cash, equity, allowances) for certain cohorts?

And be clear about what not to do:

• Don’t simply switch off NIC recycling overnight and badge it as “compliance”.
• Don’t delegate this solely to payroll; it is a strategic reward call with EVP implications.
• Don’t make pension changes without a joined-up communications plan - you will lose trust quickly.

Upgrade your narrative to employees

The combination of fiscal drag and a highly publicised “pensions raid” will be confusing and emotive. If employers don’t own the story, they will be blamed for outcomes driven in Westminster.

At a minimum:

• Build simple worked examples for typical employees at different pay levels.
• Provide clear manager briefings so that one-to-one reward conversations are informed and consistent.
• Position any changes as:
  • a legislative change that alters the efficiency of certain tools; and
  • a considered redesign of pay, pension and equity to protect long-term value, not a stealth pay cut, even if some employees will experience it that way.

Rebalance the reward mix

If salary is becoming a less efficient net-pay instrument, something else has to pick up the slack:

• Pensions: reset the employer contribution promise that is robust post-cap, separate from sacrifice mechanics.
• Variable pay: stress-test your bonus and STI frameworks - particularly where base salary growth is constrained but business performance rebounds and variable pay is the main release valve.
• Tax-advantaged equity: EMI, CSOP, SAYE and SIP have emerged from this Budget untouched (and in the case of EMI, enhanced). In a higher-tax environment for salary and NICs, their relative attractiveness improves for eligible employers and employees.
• Non-cash reward: flexibility, wellbeing, learning and internal mobility become more important as “currency” when cash is expensive and heavily taxed.

Designing reward for a tax-rich decade

Obviously, the 2025 Budget hasn’t killed salary, but it has changed its economics. Every pound of pay now works harder for the Treasury than for employees. Frozen thresholds, fiscal drag and the NIC cap on salary sacrifice mean that traditional levers deliver less net value than before.

The winners over the next five years will be those organisations that ask the right questions, e.g.

“Given a heavily taxed salary pot, what is the right architecture across pay, pensions and equity for our people and our strategy?”

That means:

• Rebalancing the mix - salary, pensions, equity and non-cash benefits.
• Stress-testing fairness - pay and tax compression and progression under frozen thresholds.
• Owning the narrative - clear communication to protect trust and engagement.

At Burges Salmon, we help employers navigate the changing reward landscape. From salary sacrifice modelling to tax-advantaged equity plans, our team advises on the design and implementation of pay, pension and reward structures that protect value and align with your strategic goals.