Thursday, November 7, 2019

The different types of Pension in the UK

Before 2012, Pension Contributions were optional and for a lot of people who had never contributed to private pensions, the State Pension paid by National Insurance Contributions (currently at £130 per week if you have 30 qualifying years) was not enough to live on.  Automatic enrolment changed this, making it compulsory for employers to automatically enrol their eligible workers into a pension scheme. Currently employees need to contribute 5% of their qualifying earnings and employers 3% (at a minimum), the objective being to supplement (and potentially replace) a State Pension that cannot cope anymore with the changes in demographics.

But not every scheme behaves the same. And it's important to understand the difference between the different schemes because some of them require that you take an extra step to claim the full tax benefits you're entitled to as failure to do so means that you will leave significant tax savings on the table.

There are basically 3 schemes available:

1. Tax relief at source

This is the most common scheme. It's used by the government owned Nest scheme as well as People's Pension. It works the same way as if you were paying yourself directly into a Private Pension: whatever is put in your pension, the HMRC adds 20% to it. In other words, only 80% of your pension contribution is deducted from your after tax salary on your payslip and it means that even if you don't pay tax (because your income is below the personal allowance), you get an pension relief of 20%. The downside however is you only ever get 20% relief even if you are entitled higher relief because you are a higher rate taxpayer.

2. Net pay arrangement

This scheme is also quite common and is used by many traditional occupational pensions (the pensions companies were using before it were compulsory). It's the one used by Now Pensions and Smart Pensions for example. The way it works is by having the payroll exempt from tax the amounts paid into your pension. The huge benefit from this scheme is that if you are taxed marginally at 40% or 45% you get full tax relief automatically without having to claim it in your tax return or by writing to HMRC (as you have to do in the tax relief at source). The downside however is that if you make less than the personal allowance and don't pay any tax as a consequence, you don't get any 20% relief from the government.

3. Salary sacrifice

This scheme is the most tax efficient as it allows you not only to save on tax but on National Insurance (both employee and employer) as well. There were rumors it would be disallowed by the government at some point, but so far, it's still an option. Under a salary sacrifice arrangement, you agree to give up part of your salary in return for your employer making a larger contribution to your pension pot. This can save you money because the National Insurance you would be due to pay is calculated on the smaller salary. The employer would pay any employer’s NICs on the smaller salary too. However doing that means that you are in effect having a smaller salary and it has potential consequences on future pension calculations,  redundancy pay or statutory maternity pay. I would also create a problem if you have employees paid at the National Minimum Wage as the sacrifice would bring them below the threshold which is illegal. 

No comments:

Post a Comment