Automatic Enrolment was introduced in October 2012 to combat the growing concerns surrounding the future of our retirement savings. It was widely recognised that most people in the UK were not saving enough for retirement and as a result may not be able to afford a comfortable lifestyle once retired. Coupled with the aging (and fast-growing) population, the sheer strain on the State Pension system would be immense in generations to come.
To combat these potential issues, the Government introduced pension reforms through the Pensions Act 2008 resulting in the recent obligation for UK employers to offer a qualifying workplace pension scheme for all employees. Those deemed eligible would be automatically enrolled, whilst those not enrolled in the scheme reserved the right to join at their request.
The minimum contributions up to 5 April 2018 were a combination of 1% employee and 1% employer contributions, which seemed fairly negligible and often went unnoticed at the time given the year on year increases to the UK tax-free personal allowances, together with the increase in National Insurance thresholds.
With effect from 6 April 2018 to 4 April 2019, the minimum contributions increased to 3% employee and 2% employer respectively. On the face of it, we would have expected a jump in opt-out rates due to employee contributions tripling within a year. However, the impact went fairly unnoticed once again, given the increase in tax and National Insurance rates. To put this into perspective, the Department for Work and Pensions had reported an opt-out rate of less than 6% in the period of April to June 2018, which was actually lower than the previous quarter.
Looking back in recent months, the final (or is it?) increase to workplace pension contributions was introduced in April this year. Employees must now pay a minimum of 5%, with the employer providing the final 3% to make a total of 8%. Many were sceptical on the face of it, but leading UK pension provider and insurer, Royal London, were not fazed by this in the lead up to April 2019. We are yet to see some hard and fast figures from the DWP, but with one of the highest increases to the personal allowance (£650 per year) and a jump in the National Minimum Wage we are probably safe to assume that opt-out rates will remain fairly consistent.
But what does this all mean – is the current level of contributions sufficient to sustain the UK pension system in years to come? Are contributions likely to increase again in the future? In short, the answer is ‘to be confirmed’. I would hazard a guess that although the contribution levels are certainly moving in the right direction, they are still insufficient in supporting the pension system by the time the likes of the Millenials such as myself and ‘Generation Z’ hit retirement age. The Pensions and Lifetime Savings Association (PLSA) have even gone as far as suggesting the minimum contribution rates could rise to 12% by 2030, with a 50/50 split between employee and employer. This would be seen as a big win for employees, seeing as the employer will be covering most of the 4% deficit between the current rates and those proposed.
This then begs the question as to whether or not it is financially viable for overseas employers to set up shop in the UK – this could potentially see employer costs of 16.8% (13.8% Employer’s National Insurance and 3% for pensions) jump to 19.8% – an increase of 18% in direct comparison. If you are looking for some additional food for thought, compare this to the likes of the Australian Superannuation scheme where employers must contribute 9.5% of an employee’s package (with optional contributions for the employee) or up to 9.75% in Germany.
The word ‘pension’ is now on the tips of UK tongues more now than ever, but what could we being to ensure we are getting the most out of the workplace pension?
Pensions and tax treatment – room for efficiency
When an employee pays into their workplace pension, they should receive tax relief on any contributions they make. This is at the highest rate of tax that they may pay, providing the total gross contributions paid in to the scheme (by anyone) do not exceed the lower of the their annual earnings, or the annual allowance which is currently £40,000 per annum.
The way employees receive tax relief on their contributions depends on the type of scheme and provider. As standard, the two methods are as follows:
‘Net pay arrangement’ – employer should deduct contributions from taxable pay, before tax is deducted. This means that tax relief is received at the highest rate of tax that the employee pays.
‘Relief at source arrangement’ – the employer will deduct contributions from net pay, after taxes have been deducted. Deductions are made at the agreed contribution rate, less 20% for basic tax relief. When the contributions are paid to the provider, they will reclaim this from HMRC and transfer the difference to the pension pot. As only 20% is reclaimed, higher-rate tax payers will need to claim their additional tax relief through a self-assessment tax return.
The potential pros and cons when comparing the two methods can be seen below:
|Consideration||Net pay arrangement or ‘pre-tax’||Relief at source arrangement or ‘post-tax’|
|Reclaiming tax relief||The relief is given to the employee instantly, by reducing taxable pay and therefore tax deductions||The relief is given instantly to a basic-rate taxpayer, but will be delayed by one year for a higher-rate tax payer|
|What if I do not pay tax?||A lower paid employee (or those
who do not pay tax) will not (typically) receive any form of tax relief
|A lower paid employee (or those who do not pay tax) will benefit from 20% tax relief|
In short, depending on how much an individual earns and their personal tax situation, either arrangement could be suitable. Of course, the tax relief basis is dictated by the chosen pension provider and in a majority of cases is set in stone.
However, there is another method that is worthwhile considering when it comes to pensions – salary sacrifice. Salary sacrifice is what it says on the tin – an employee sacrifices a portion of their salary, in exchange for the non-cash benefit of an enhanced employer pension contribution.
The caveat is that because some salary is sacrificed, both tax and National Insurance Contributions (NIC) are reduced – employees reap the benefit of reduced tax deductions and NICs (and let’s not forget the employer savings in Employer’s NICs)!
Now although this sounds like a no-brainer in principle, there are some considerations to make before rolling out salary sacrifice across the workforce. By reducing your pay subject to NICs, this may affect an employee’s entitlement or eligibility for certain benefits or life-events such as:
- the State Pension
- contribution-based state benefits
- statutory parental leave (e.g. maternity or paternity)
- mortgage applications
- life cover
Similarly to the net pay arrangement, lower paid employees (or those not paying tax) will not receive the tax benefit, or potentially the NIC benefit in some cases. Finally, salary sacrifice schemes could quickly become an administrative burden as you must monitor who has or hasn’t elected to the scheme, issue formal documentation outlining the principles of salary sacrifice and collate agreements for those who have chosen to opt for sacrificial contributions.
Does the saving in employer’s NICs outweigh the administrative burden? It certainly does; more so for the larger employer, but unlikely for the smaller employer.
If you have any questions regarding your workplace pension scheme or would like to review your current arrangement, please contact Sam Worf-Spicer.