Updated 04 November 2020
Company pension contributions are what make workplace pension schemes so much more attractive than most personal pension schemes, by giving your retirement savings an extra boost. But they’re also good if you yourself are an employer, as they are a tax-efficient way to reward your workers while paying less in National Insurance contributions.
Read on to find out the benefits of employer pension contributions for both workers and bosses.
When you have a workplace pension, you and your employer make contributions to it. The money gets invested to help it grow with the aim of giving you income when you retire. Thanks to auto-enrolment, it is now a legal requirement for employers to enrol eligible staff onto a pension scheme.
Both employees and employers are then obliged to pay contributions into the pension every month, to a statutory minimum level (though they may pay in more).
Under auto-enrolment, there are minimum contributions that both you (the employee) and your employer must make, which are percentages of salary. Normally, employers pay at least 3% and employees pay at least 5%.
The percentages are usually (but not always) calculated on qualifying earnings, which is the amount earned (including bonuses and overtime etc.) before income tax and National Insurance contributions are deducted, between £6,240 and £50,000. That means the first £6,240 of earnings aren’t included, or any earnings over £50,000.
Example: Bob is on a salary of £35,000 and earns £5,000 through overtime, so his qualifying earnings are £33,760 (£40,000 minus £6,240). His employer must contribute a minimum of 3% of £33,760, so they’ll pay £1,012.80 a year into Bob’s pension fund.
Employers can pay more than the statutory minimum, and may do so through other arrangements such as a salary sacrifice pension scheme. If an employer is paying more than the minimum through any arrangement, they can reduce their standard contributions, but never below 3% – and they’ll usually have to consult with the employee before doing this.
How much your employer can contribute depends on the scheme you’re in. If your employer uses the qualifying earnings system, for example, the percentage is based only your earnings between the £6,240 and £50,000 band. Any of your qualifying earnings over £50,000 aren’t considered. Your employer however may choose to increase the percentage. If the employer is using a salary sacrifice scheme, there is no maximum contribution, but your salary can’t fall below minimum wage.
As an employee, you can pay as much as you like into your pension pot within your pension allowances and still receive tax relief. The maximum annual amount is either 100% of your salary or £40,000 a year, whichever is higher. Company directors who take much of their income as dividends and pay themselves only a low salary are more at risk of crossing this threshold.
Employer contributions are essentially extra remuneration, although you have to wait longer to spend it. This means you should look carefully at the rules of your workplace pension and see how your employer’s contributions work.
For instance, is the amount fixed, or does it change based on how much you contribute? Some employers match your own payments, and some pay in double what you contribute (or even more). Therefore, every increase you make in your own contributions can be magnified by your employer’s policy here.
Here’s an example. Isobel’s employer offers matching contributions. If Isobel pays in the minimum 5%, her employer pays in 10% - making 15% in total. But if Isobel increases to 6%, her employer pays in 12%, making 18%. So Isobel gets a large increase in overall contributions at relatively low cost to herself.
Even if your employer’s contribution levels aren’t affected by your own, you can still maximise their impact by contributing as much as you can. All contributions earn compound interest, so the bigger the sum, the faster the interest will accumulate and grow.
Remember that only your income can be used to calculate your pension annual allowance – dividends don’t count. So if you take most of your income as dividends (e.g. because you are company director), your tax relief limit will be low.
If you want to increase the limit, there are two ways: either increase your salary (which may increase the amount of income tax you pay), or make the pension contribution directly from your company as a larger employer contribution.
Employer pension contributions count as an allowable business expense, meaning you can deduct them from your taxable profits to reduce your corporation tax bill. What’s more, employers don’t have to pay National Insurance on pension contributions. If you’re a contractor working under your own limited company, these rules mean that paying contributions directly from your company can be tax efficient.
Tax relief on pension contributions can make increasing the amount you contribute a tax-efficient way to save for the future. Basic rate income tax payers can claim 20% tax relief, higher rate taxpayers can claim 40% and additional rate taxpayers can claim 45%. Tax relief on pension contributions effectively reimburses the income tax that you’ve paid on that money.
It’s therefore very tax-efficient to pay into your pension, until you approach your annual or lifetime allowance. If you exceed either of these, you will face tax charges again which cancel out any tax savings. Remember though that you can bring forward unused annual allowances from the previous three years.
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