Workers will be automatically enrolled into the new system
A cap of £3,600 is to be placed on annual contributions to the government's Personal Accounts pension scheme, due to be launched in 2012.
Under the system, employees will contribute 4% of salary, matched by 3% from employers and 1% in tax relief.
Employees who are not already in a workplace scheme will be automatically enrolled into a personal account.
An average earner saving £3,600 a year should end up with a pension equal to two-thirds salary, the government said.
The government has faced a tricky decision in setting the maximum annual contribution level for Personal Accounts.
Set the limit high and Personal Accounts could kill-off the private pensions industry and also add costs to employers.
On the flip side, set the limit low and people will not be able to save enough in order to build up a big enough pension pot, consumer groups have said.
"We think what we are doing today strikes the right balance in targeting it (personal accounts) and making sure people can make enough contribution," James Purnell, Pensions Reform Minister, told the BBC.
The Association of British Insurers (ABI), which had been lobbying for a lower contribution limit, said it was "pleased that the government has listened to our concerns... we can live with this."
TUC general secretary Brendan Barber said that he would have preferred a higher contribution cap but welcomed the fact that the cap will be index-linked.
Mr Barber said the government's announcement on Personal Accounts was a "red letter day" for pensions.
"Today is a significant day in the history of pensions and should be recognised as such," he said.
"We are particularly pleased to see that ministers have held fast to their rejection of the call made by some employers to introduce a waiting period before new employees could claim an employer contribution," he added.
On Monday, the Equal Opportunities Commission (EOC) warned that the money built up in a personal account could bar some from claiming means-tested benefits.
The EOC said that some people could find they are worse off under the new Personal Accounts system, losing more in benefits than they gain through personal accounts.
In particular, women, who earn less than men on average, are among those most likely to fall into this trap.
in 2004, the government's Pensions Commission estimated that up to 12 million people were not saving enough towards their retirement. The system of Personal Accounts is specifically designed to reduce this number.