Pension contributions: effect on state benefits

Overview

If you get a means-tested benefit like universal credit your pension contributions reduce the amount of income that is taken into account in assessing your award. This could mean a higher award of universal credit is made to you. 

Universal credit

Universal credit’s taper rate of 55p in the pound on earned income means that a gross £100 pension contribution over the course of a year could result in a £55 increase in your UC award depending on your level of award and circumstances.

How pension contributions affect the calculation of earned income

When calculating earned income for the purposes of universal credit, you are allowed to deduct any relievable pension contributions you made in the universal credit assessment period. This is the case for both employment income and income from self-employment.

We understand that the DWP currently deduct the following in respect of pension contributions:

• For pension contributions to a relief at source scheme – the contribution net of basic rate income tax
• For pension contributions to a net pay arrangement scheme – the gross contribution including tax relief at the basic rate of income tax.

However one interpretation of the legislation is that for relief at source schemes you should deduct the gross pension contribution, not the net contribution as is DWP practice. The Universal Credit Regulations do not distinguish between contributions to different types of scheme, whereas the DWP appear to treat net pay arrangements and relief at source schemes differently. This is something that would need to be considered and ruled upon by a Tribunal.

You may have to tell the DWP about your pension contributions in order for them to take the deduction into account. In other cases, the DWP may already know about your pension contributions – so you will just need to check they are taking the correct amount into account. Your position will depend on the type of pension scheme you are in and whether you are an employee or are self-employed.

Employees – net pay arrangements

If you are in a net pay arrangement, your employer deducts your pension contributions from your pay before calculating your income tax under PAYE and paying you. They report your pay, tax, National Insurance contributions and your pension contributions to HMRC each time they pay you, under Real Time Information (also known as RTI). HMRC pass this information to the DWP automatically. You should check that the deduction is correct on your universal credit award and matches your payslip.

Since your employer has reported your gross pension contributions inclusive of basic rate income tax relief, the DWP deduct your gross pension contributions when working out your universal credit entitlement.

Employees – relief at source pension schemes

If you are in a relief at source pension scheme, your employer deducts your pension contribution from your net pay, after tax and National Insurance contributions have already been calculated. They pay this into your pension scheme and the pension scheme claims tax relief from HMRC. 

Your employer reports your taxable earnings to HMRC, before deduction of pension contributions, but also sends details of the pension contributions made via the payroll to HMRC each time they pay you. This information is then passed on to DWP automatically. DWP will deduct the pension contribution amount from your earnings when calculating your universal credit. You should check that the deduction is correct on your universal credit award and matches your payslip.

Employees and self-employed – private pension schemes

If you are an employee who pays into a private pension scheme not related to your employment or if you are self-employed and pay into a private pension scheme, you have to notify the DWP every month about your pension contributions. If you are not self-employed, you notify DWP by entering your pension contributions into your universal credit journal online. If you are self-employed, you notify DWP when reporting your income and expenses from your self-employment using your online universal credit account.

DWP guidance says they will ask for the amount of pension contributions that you have actually paid. Since you pay the pension contributions net of basic rate income tax (the pension scheme obtains tax relief from the government and adds it to your pension pot), DWP practice is to only deduct the amount you personally paid into the pension (the net pension contributions) when working out your universal credit entitlement. As noted above, one interpretation of the legislation is that DWP should allow a deduction for the grossed-up amount, in other words your contribution should be multiplied by 1.25. This is something that would need to be considered and ruled upon by a Tribunal.

Salary sacrifice

If you are an employee and use salary sacrifice to make your pension contributions, you do not need to report your pension contributions to DWP. The amount of taxable earnings that your employer reports to HMRC using real time information will already reflect the pension contributions and salary sacrifice.

Universal credit thresholds

There are various thresholds in universal credit (such as the administrative earnings threshold). Some thresholds look at income before deductions, but others look at taxable income or income after various deductions. So it is important to understand how the way you pay pension contributions might affect your position for these thresholds.

Carer’s allowance

We look at the relationship between pension contributions and carer’s allowance in this part of our website.

Child benefit

Child benefit is tax free, although if you claim child benefit and either you or your partner has adjusted net income of more than £60,000, the higher earner will be liable to pay the high income child benefit charge (HICBC).

The more pension contributions you make, the lower your adjusted net income, therefore making pension contributions may reduce the amount of HICBC you have to pay.

Other benefits

Pension contributions may impact on other benefits. You should check the position carefully for whatever benefit you are claiming. 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.