Pensions are a tax-efficient way of saving for your retirement. The UK government introduced legislation in 2012 which stipulates that all employers must provide a workplace pension scheme, this is known as ‘automatic enrolment’. Since 2012 all eligible employees must be automatically enrolled - and then they can choose, if they wish, to opt out. 
The amount the employee, their employer and the government pay towards the pension depends on which type of pension scheme is being used. It also depends on whether the employee was auto-enrolled or if they opted in. 
 
An individual can have a workplace pension, which is required by law to be offered by the employer, or a personal pension, where the individual makes the arrangement themselves. 
 
There are two main types: 
 
- Defined contribution pension: based on how much is paid in. 
- Defined benefit pension: based on salary amount and how long the employee has worked for that employer. 

Defined contribution pension (most commonly used for auto-enrolment) 

These pension schemes are sometimes known as ‘money purchase’ pensions as it is the contributions that are defined and fixed. 
 
They can be: 
 
- Personal pension arranged by the individual. 
- Workplace pensions arranged by the employer. 
- Stakeholder pension, which must meet specific government requirements. 
- Self-invested personal pensions (SIPPs), which allow the individual to control the investments made by the pension fund. 
 
The money paid into a pension is put into investments, such as shares, by the pension provider. Because of this, the value of your pension can increase or decrease, depending on how the investments perform. 
 
The amount received when the individual retires and starts to draw their pension depends on how much was paid in, how well the money was invested and how the money is withdrawn, i.e. as regular payments or as a lump sum. 
 
25% of the total pension is usually tax free and the pension provider takes a small percentage as their management fee. 

Defined benefit pension 

These schemes are usually workplace pensions that are arranged for the employee by the employer. They’re also known as ‘final salary’ or ‘career average’ pension schemes. 
 
A workplace pension works by a percentage of the employees pay going into the pension scheme automatically every payday and, in most cases, the employer also adds to the pension 
 
How much the individual receives when retiring depends on the rules of the pension scheme, how long the employee worked for that employer and how much their salary was; and is not affected by how much is paid in or how it was invested. 
 
The employee can usually choose to get 25% of the pension fund tax free and the rest as a regular payment. 

What the employee and employer pay 

The exact amount paid into a pension pot can vary depending on the type, workplace or private pensions, and the rules of each pension scheme. 
 
Workplace pension – auto enrolment 
 
If the employee was automatically enrolled, then they and their employer must pay a percentage of the employee’s earnings into the workplace pension scheme. 
 
Most auto enrolment schemes are based on the employee’s total earnings of between £6,240 and £50,270 a year, before tax. This amount includes salary/wages, bonuses, commissions, any overtime and statutory sick, maternity, paternity or adoption pay. 
 
From April 2019, the minimum workplace contribution is 8% of total earnings, made up of 5% from the employer and 3% from the employee. 
 
Workplace pension - voluntarily enrolled 
 
The employer must contribute a minimum amount if the employee earns more than £520 a month or £120 a week or £480 over 4 weeks. If the employee earns less than this, the employer does not have to contribute anything. 
 
You can use the Money Advice Service’s calculator to work out how much the employee and employer will need to contribute. 

Tax implications 

Government tax relief 
 
The UK Government will usually contribute to workplace pensions in the form of tax relief if the employee pays Income Tax and they pay into personal or workplace pension. 
 
Pension tax implications for the company 
 
Tax relief is given to limited companies who contribute to a pension scheme by allowing these contributions to be deducted as a business expense and offset against the company’s Corporation Tax bill. 
 
Pension tax implications for individuals 
 
By joining a workplace pension scheme, take-home income will decrease for the individual, as a portion of their salary will go into their pension fund. 
 
If an individual’s salary is lower, it may mean they’re entitled to tax credits, income-related benefits and reduced student loan repayments (if applicable). 
 
*Note all rates and figures quoted are correct at time of publication and are based on 2021/22 rates. 
 
How we can help 
 
Pension types, payment amount and tax relief options available can be confusing as there are so many permutations. You can contact us and we’ll help guide you through your options as an employer and employee. 
 
 
 
 
Written by: 
 
Nicola J O'Sullivan -  
Effective Accounting 
 
Founder | Xero Champion | IR35 Expert 
 
 
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