What employers should know about pension contributions
What are Pension Contributions?
Pension contributions are payments made into a fund to secure an individual’s retirement. Contributions are usually made by an employee, their employer and sometimes also through the government. An employee can choose to change their pension contributions at any time but will need to meet the minimum contributions set out by The Pensions Regulator.
When an employee is automatically enrolled into their employer’s workplace pension scheme, minimum contributions have to legally be made. For most pension schemes, the total contribution must be a minimum of 8%. An employer must contribute at least 3% of their employee’s pay, and the employee will need to make up the difference of 5%.
What are the benefits of contributing to a pension?
Contributing to a pension helps to ensure that individuals are well catered for when they retire and are no longer in employment. A large benefit of contributing to a pension scheme is that employees do not have to rely solely on the state pension which is normally not sufficient enough to cover all living expenses in retirement. The full state pension for the tax year 2021/2022 is £179.60 a week for an individual. This may not allow someone to live the retirement lifestyle that they desire.
Employees who are on a Relief at Source scheme receive tax relief from the government on their pension contributions. This means that money which would usually have gone to the government as tax is returned to an individual’s pension pot.
If an employee has contributed to a pension through a defined contribution scheme, their contributions are invested. This means that depending on the performance of the market, they grow throughout the employees working life and provide them with a steady income during retirement.
A workplace pension scheme involves an employer making pension contributions on behalf of employees. This is beneficial because an employee is able to increase their pension pot considerably at no extra cost to them.
In terms of inheritance tax, pensions tend to fare well compared to other savings investments. If an individual passes away before the age of 75, their pension can usually be passed onto someone else as a lump sum without inheritance tax being deducted.
In general, contributing to a pension is beneficial to employees as when they reach retirement age, they will not have to worry too much about having enough money to achieve their desired lifestyle.
What is basic pay?
Basic pay is a term used to describe the method used for calculating contributions for defined contribution pension schemes. When this method is used, pensionable earnings refers to an employee’s basic salary before any bonuses, overtime or commission is applied. However, when using this type of pensionable earnings criteria, the employer will need to contribute a minimum of 4% and the employee makes up the difference to a minimum total of 9%.
Qualifying Earnings can be used by employers to determine the pensionable pay used to calculate the pension contributions. The qualifying earnings thresholds currently relate to an employee’s earnings between £6,240 and £50,270 a year. These figures are reviewed every year by the government.
Using this method, employees contribute a percentage of their earnings which fall between £6,240 and £50,270 per annum. The first £6,240 of their earnings isn’t included in the calculation. For example, if a worker earns £30,000 their qualifying earnings at 5% would be £1,188.
This means that qualifying earnings can’t be more than £44,030 (£50,270 minus £6,240) for the 2021/22 tax year. If you pay your staff monthly, these figures would reflect earnings between £520 and £4,189 per month so the maximum any employee’s pensionable earnings would be is £3669 per month.
Earnings which have to be included in the above calculation must include all of the following: