Workplace Pensions: How Do They Work And How To Get Involved
On Monday, September 6, 2021 -
What is a workplace pension?
A workplace pension scheme is a way of saving up for your retirement where you contribute towards your pension directly from your salary or wages, before it hits your bank account. By law, your employer has to offer a workplace pension scheme and enrol you on it automatically if you’re eligible. If you’re eligible for auto-enrolment, your employer is legally required to contribute towards your pension savings, and you’ll get tax relief on your pension contributions, too.
What’s auto-enrolment?
Automatic enrolment is where you’re automatically enrolled onto your employer’s workplace pension scheme because you meet certain eligibility criteria. These include:
- Being aged 22 or over
- Being under state pension age
- Not currently contributing to another workplace pension scheme
- Earning more than £10,000 a year
- Working in the UK
If you’re not eligible for auto-enrolment because you don’t meet one or more of these criteria, you can usually join your employer’s scheme on a voluntary basis if you like, and your employer can’t stop you. But, they don’t have to pay in if you join the scheme voluntarily and aren’t eligible for auto-enrolment.
What is tax relief?
Tax relief is where you pay less tax to account for money you’ve spent on certain things, or – as is usually the case with pensions – you get tax repaid to you. With pension contributions, the tax relief you’re entitled to will normally be calculated and paid directly into your pension fund automatically. But, sometimes, and particularly if you’re eligible for additional tax relief, you will need to apply for it.
With private pensions, you can get tax relief on contributions towards your pension worth up to 100% of your annual earnings. Tax relief is paid at a rate of 20% for most people, and you’ll get it automatically – as in, your pension scheme provider will claim it and add it to your pension on your behalf – as long as you’re contributing to your pension through a workplace pension scheme and your contributions are taken before tax, and you pay the basic rate of tax. If you pay the higher or additional rate of tax on any of your income, then you may be able to claim additional tax relief on your pension contributions. You can claim 20% tax relief up to the amount of any income you’ve paid higher rate tax on, and 25% tax relief up to the amount of any income you pay the additional rate of income tax on. It’s better explained with an example:
Let’s say your income is £60,000 and, between you and your employer, you’ve paid £15,000 into your pension. Because the amount you’re contributing is less than you’ve earned over the course of the year, you’ll automatically get 20% tax relief on the full £15,000 claimed for and handled by your pension provider. This equates to £3,000. But, because you paid the higher rate of income tax on £10,000 of your income, you can also claim an extra 20% tax relief on £10,000 of the amount you contributed to your pension through a Self Assessment tax return. This equates to £2,000, making your total tax relief for the year £5,000.
The different types of workplace pension
There are two main types of pension scheme that your employer may offer as a workplace pension. The first of these is a defined benefit pension, and the second is a defined contribution pension.
Defined benefit pensions
Defined benefit pensions – commonly known as final salary schemes – are a type of pension where the amount you receive is based on the salary you earn at the point you retire, and the amount of time you’ve been part of your employer’s scheme. Typically, you’ll contribute a set percentage of your salary towards your pension, and your employer will pay the rest. The money is then held by your employer, and they are responsible for ensuring there’s enough money available to pay your pension at the time you retire.
Defined benefit pensions, while once popular, are less common than they used to be. Most employers now offer different types of pensions that cost them less to operate.
Defined contribution pensions
Defined contribution pensions are a type of pension where the amount you receive as a pension is based on the amount you’ve paid in and how the investments that money was put into have performed over the years. You’ll usually pay in a set percentage of your salary, and, if this type of pension is being offered to you as a workplace pension with automatic enrolment, your employer will contribute a percentage of your salary, too.
Defined contribution pensions are the most common type offered by employers these days. You might hear them talked about with names like “money purchase schemes”, “group personal pensions” or “stakeholder pensions”, and while there are some small differences between them, the way your pension entitlement is calculated is the same.
Even if you’re not eligible for automatic enrolment in your employer’s workplace pension scheme, you may be able to join it voluntarily if it’s a defined contribution pension scheme.
How workplace pension schemes work
Once you’re enrolled in your employer’s workplace pension scheme, then you’ll pay a percentage of your salary into your pension each month, and if your employer is contributing, they will also pay a percentage of your salary into your pension each month. Importantly, the contributions you make to your pension are usually deducted from your salary both before it hits your bank account, but also before you’re taxed on it. This is called a salary sacrifice, and means you reduce your earnings slightly in order to receive a non-cash benefit – in this case, your pension. Because your earnings are reduced, the amount of your income you pay tax and National Insurance on reduces a little too. And we all love paying less tax!
How much do you pay into a workplace pension?
Currently, under auto-enrolment rules, the least you can pay into your pension each month is 5% of your salary, and your employer must contribute 3%. Of course, you can opt to pay in a higher percentage if you want to, and many employers will offer to match your contributions up to a certain amount. But, at the very least, 8% of your salary will be added to your pension each month between contributions by you and your employer.
What happens when you’re enrolled in a pension scheme
When your employer automatically enrols you in their pension scheme, they must write to you to let you know, and provide you with details of the scheme. They must let you know:
- The date you were added to their pension scheme
- What type of pension scheme it is (i.e. is it a defined contribution or defined benefit pension?)
- Which pensions provider they’re working with to offer their pension scheme
- How much you will be contributing, and how much they’ll pay in each month
- About tax relief, and if and how it applies to you
- How to leave the scheme, if you ever want to
If I start a new job, will I contribute to my pension straight away?
Maybe, maybe not. It depends on your employer’s policy on this. By law, employers are allowed to delay your enrolment in any defined contribution pension scheme by up to three months from your start date. If you won’t be joining your employer’s pension scheme immediately when you start working there, they must let you know about the delay in writing, and allow you to join and start contributing in the meantime if you ask to. If you join your employer’s pension scheme early, though, then they may not start making their contributions at the same time.
Employers may be able to delay enrolling you into their pension scheme for longer if all or part of the pension scheme they offer is a defined benefit pension. But, as a general rule, any longer than three months delay is a big no-no that could land them in some legal hot water.
Do you have to enrol in a workplace pension?
While your employer will automatically enrol you in their pension scheme if you’re eligible to join it, being part of a workplace pension scheme isn’t mandatory. You can opt out of your employer’s pension scheme if you choose to, by letting them know in writing. However, as long as you can afford the contributions, the benefits of enrolling in your employer’s workplace pension scheme make it well worth doing!