There has been a lot of information recently about the need for an employer to have a new compulsory Auto Enrolment Pension Scheme but not much about how they work.
What is an Auto Enrolment Scheme?
The government have made it compulsory for every employer with ordinary employees to have a special compulsory pension scheme. This may be in addition to other schemes or the only one.
As this is a compulsory scheme then every ordinary employee has to join; it is compulsory.
Ordinary employees are those earning over £833 in the month, who are between the ages of 22 and state pension age and who are not directors.
Enrolment must be within 3 months of becoming an eligible employee of an employer who has passed their staging date (the date these new rules apply to that employer).
The first some employees may know about it, is when they get a lower wage due to so called compulsory contributions – but contributions are NOT compulsory, AND you can leave at any time!
What if I want to leave?
When you have been enrolled then you should be advised by your employer and the pension company. The pension company will then tell you how to leave. This is called opting out and can usually be done on-line or by giving your employer a special code.
You may be enrolled before or as your first contributions are deducted from your wages but if you opt out immediately then your contributions will be returned.
If you already have a big pension pot, then it is essential to get financial advice, as not opting out could cause a big tax bill on your existing pension pot.
What if I do nothing?
The government’s aim with these schemes is to make every employee have their own pension so they are not so reliant on the state pension. The old stakeholder pension scheme rules made employers set up schemes but that was not good enough. Hence if you do not opt out then it is compulsory to make contributions to the Auto-enrolment Scheme i.e. pay in.
The government have set a minimum that must be paid in. That minimum was announced well in advance and is set to grow over the next few years.
Additionally, the government have said that employers can not just deduct it all off the employee, and have capped the part that can be taken off the employees pay.
This all means that as long as it is above the minimum amounts then you and your employer can pay in as much as you like; and for every £4 you as the employee pay in then HMRC will pay in £1 as tax relief.
So the real question is what is your employer planning to do or offer you.
But also what effect will this have on any existing pension arrangements you may have in place e.g. Will it replace the current employer scheme you are a member of?
One final twist – the minimum contribution specified by the Regulator is a percentage of “qualifying earnings” i.e earnings between £112 per week and £827 per week – NOT the whole salary – so again what is your employer planning?
Typical current Examples of employer offerings are as follow:-
1 The minimum 2% total contributions of which the full maxim of 1% is funded by the tax paying employee
£100 funded by the employer
£80 deducted from the employee’s net pay
£20 added by HMRC
2 The minimum 8% total contribution expected by the time the scheme is rolled out to all employers 6th April 2019, but with the employer not making use of the option of getting the employee to fund up to 5 % (maybe instead of a pay rise or part of a new pay deal or replacing existing pension arrangements)
£800 funded by the employer
But What is most tax efficient?
Pension contributions are tax allowable, hence if the employee pays then they get the tax back. (Basic rate tax relief straight into the pension fund and higher rate relief via the employees tax return.)
Pension contributions paid by the employer count as part of the employees payroll package so are tax deductible on the employer who is in business, but not to those employers who are not in business e.g. employing domestic staff
Pension contributions are not subject to tax or national insurance if paid by the employer. Hence contributions paid direct by the employer have a national insurance saving for both employee and employer so are most tax efficient.
Firstly – do you like what your employer is offering? If so then you need Do nothing.
If you are not an “ordinary employee” but others are, then you may be able to join in too. Your employer is obliged to pay in at least minimum contributions for those between the ages of 16 and 75 who have chosen to join in.
Would you like to pay in extra sums?
Or would you like to opt out?
Finally, if you are paying contributions personally then do not forget to ask for additional tax relief via your tax return or tax code, if you are a higher or additional rate tax payer.
We here at Limelight can help you set up and administer your auto- enrolment scheme as an employer or complete your personal tax returns but employees will need to take independent financial advice about investments.