Four reasons not to panic over pension contribution increase
If you have been automatically enrolled into a workplace pension, from 6 April you will probably have to pay more into your pension pot. But here are four reasons why this may not cost you as much as you think.
Under the auto-enrolment scheme, from 6 April 2019, you will probably be required to increase the amount of your minimum pension contributions from 3% to 5%. We have detailed guidance about auto enrolment on our website.
If you are on a low income, we understand that the contribution increase may mean that you start to wonder whether you can afford to stay in your workplace pension.
If you do decide to opt out, you will be able to cease your active membership of the pension scheme but usually will not be able to claim any contributions back (they will remain in the scheme until your retirement). However, you should think very carefully before opting out as pension saving is usually a good idea!
In addition, it may be useful to know that the contribution increase may not cost you as much as you think, for the following four reasons:
1. The increase won’t be operated on all of your earnings
The 5% will not apply to all of your earnings – it will only apply to your ‘qualifying earnings’.
In 2019/20, qualifying earnings are those from £118 per week up to an upper limit of £962 per week (£512 and £4,167 a month).
Petya pays pension contributions each month based on her salary of £1,500. The first £512 of this is not counted so she will only have to pay contributions based on £988 each month. At 5%, this is £49.40 per month.
The Money Advice Service provide a free workplace pension contribution calculator which you can use to help work out roughly how much you will have to contribute from April, based on your earnings (make sure you change the default percentage setting from 3% to 5%).
2. You may be getting a pay rise to help cover the cost
If you are on the minimum wage, you will be getting a pay rise from 1 April, so this will help offset the extra cost of the contributions.
From 1 April 2019, the National Living Wage (NLW) and National Minimum Wage rates (NMW) are:
- £8.21 for workers aged 25 and over (up from £7.83 per hour) – this is the NLW
- £7.70 for 21 to 24 year olds (up from £7.38 per hour)
- £6.15 for 18 to 20 year olds (up from £5.90 per hour)
- £4.35 for 16 to 17 year olds (up from £4.20 per hour)
The NMW rate will be £3.90 for apprentices (up from £3.70 per hour). Apprentices qualify for the lower apprentice rate if they are under 19, or still in the first year of their apprenticeship contract.
If your employer provides you with living accommodation, the maximum they can deduct from your pay to cover the cost (from 1 April 2019) is £7.55 a day or £52.85 a week.
You can find out more about how the minimum wage works in our website guidance.
3. The increased amount could be taken into account in your tax credits/universal credit award
Paying increased contributions may mean that your take-home income will be reduced. But if you get a means-tested benefit like universal credit (UC) or tax credits, your pension contributions reduce the amount of income that is taken into account is assessing your award.
For example, universal credit’s ‘taper rate’ of 63p in the pound means that a £100 pension contribution over the course of a year could mean you get up to £63 more over the same period, depending on your level of award and circumstances.
You should check the position carefully for whatever benefit you are claiming as the steps you need to take to make sure the authorities know about your pension contribution amounts, might depend on whether you are in a net pay scheme or relief at source.
For example, tax credits are based on gross income – before tax and National Insurance are deducted. If you make contributions under a net pay arrangement then the taxable income figure on your P60 will already reflect your pension contributions. You won’t need to make any further adjustments for pension contributions.
But the gross income figure from your P60 will not reflect any relief at source pension contributions and you will therefore need to deduct your pension contribution amount from your income figure when you report it to HMRC. The amount to deduct is the amount of pension contribution grossed up by 100/80 – to reflect the 20% top up that will be claimed from HMRC by your pension scheme.
You can read more about this on our website for advisers, RevenueBenefits.
4. You could get tax relief to help make up your contribution amount
As set out in our recent news article ‘Do you understand how tax relief on your pension contributions works?', if the pension scheme you are in uses a ‘relief at source’ method of tax relief, then the scheme provider is able to claim 20p in tax relief from the government on every 80p you pay in, regardless of how much you earn (this will be paid directly by the government into your pension pot). The tax relief therefore means that your 5% contribution is only really a 4% contribution.
For example, if you earn £300 a week, and want to pay £10 in a pension contribution, you will only actually have £8 deducted from your pay, and the government will put £2 into the pension scheme by way of tax relief at a later date.
Some other pension schemes use a different approach (‘net pay arrangements’), under which your pension contributions are deducted from your salary by your employer before income tax is calculated on it, so you get relief on the amount immediately at your highest rate of tax.
So, if you earn £300 a week, and pay £10 in a pension contribution, you will only pay tax on wages of £290. As you don’t pay tax on the £10 of your earnings that you put in as your pension contribution, you are therefore saving tax of £2 (£10 x 20%), meaning your £10 contribution is only really costing you £8.
Please note that net pay arrangements mean that employees do not get any tax relief unless their earnings are more than £12,500 (in 2019/20), so if you are on a low income you should check which type of pension scheme you are in.
Many people think that it is unfair that low-paid workers in net pay arrangements don’t get tax relief. There are growing calls, including by LITRG, for the government to change the rules. If you are in a net pay arrangement and feel aggrieved by the fact you are not getting tax relief (particularly if you thought you were), please consider writing in to share you experience with us. Any evidence or examples we can collate about the impact of the net pay problem on people, may help bolster our case for change.