Man dropping coin into small glass jar labelled 'Pension'
Back to Basics: Employer Pension Contributions

With September comes (even) cooler weather, the end of the holiday period and the start of a new school year. It also brings Pension Awareness week, which this year ran from 9 September. The week is intended to help individuals understand how best to save for their future, and the website and event recordings might make a useful reference to share with your employees.

Understanding pensions is key for employers too. So for this month’s back to basics, we are taking a look at some of the tax issues around pensions which employers need to know.

Auto-enrolment

Pensions are a big deal for employers as all employers must, by law, operate a workplace pension scheme to ensure that eligible job holders are enrolled into a qualifying scheme. This is called auto-enrolment.

Employers are responsible for identifying which of their employees qualify for auto-enrolment, selecting a suitable scheme and then making a minimum level of contributions.

Identifying those who need to be added to a pension scheme can be complex, but the basic definition is that anyone who is a

  • worker;
  • aged between 22 and the state pension age;
  • earning over £10,000 a year; and
  • who usually works in the UK;

should be enrolled, unless they opt out or fall within a very limited number of exemptions when auto enrolment is not compulsory.

It’s important that employers get these foundations right, and there are more details on how to get started with auto-enrolment as a new employer on The Pensions Regulator’s website.

Contributions

Once enrolled, employers must make a minimum contribution towards their employees’ pensions.

For the tax year ending 5 April 2025, this minimum contribution is 3% of the employee’s total earnings between £6,240 and £50,270. Total earnings includes basic pay, plus bonuses, commission, overtime and statutory sick pay or maternity pay.

For example, for an employee earning £20,000, the minimum pension contribution that their employer would have to pay on top of their salary is 3% x (£20,000-£6,240) = £412.80.

Of course an employer can contribute more if they wish. Employees are also required to make a minimum 5% contribution.

Tax aspects for employers

Employer pension contributions are a tax-free benefit – so unlike other employee benefits, there are no employer’s national insurance consequences. Employers can also get tax relief for the costs of staff pension contributions.

Tax aspects for employees

As a tax-free benefit, employees don’t pay income tax or national insurance contributions (NICs) on employer contributions to their pensions.

There are though limits on the amount an individual can save into a pension each year, and if an individual’s total pension contributions, including their employer’s contributions, exceeds that limit they may have an income tax charge to pay. The limit depends on their income level, and whether they have any unused allowance for previous years. Full details of the annual allowance is beyond the scope of this article.

In most cases employees will also make their own contributions to the scheme. These employee contributions are eligible for income tax relief, but how the employee gets that relief depends on the type of pension scheme operated by the employer. This is important and one of the big decisions the employer should make when selecting a scheme.

Paying into the scheme – tax relief for employee contributions

A pension scheme generally operates to give relief for employee contributions in one of two ways:

  • Relief at source
  • Net pay

Relief at source

This is the default method of providing tax relief for all registered pension schemes set up since April 2006.

An employee’s pension contributions are made after tax and National Insurance contributions have been deducted from their gross pay. Basic rate tax relief is then claimed by the pension scheme administrator on the amount paid to the pension fund on behalf of the employee.

For instance, if an employee in England, Wales or Northern Ireland (Scottish tax rates differ) wants to add £100 to their pension fund, their employer would need to take £80 from their after-tax pay and pay it into their pension fund. The scheme administrator would then claim an additional £20 from HMRC as basic rate tax relief, giving a total of £100 added to the fund.

The term relief at source is potentially misleading, because only basic rate tax relief is given automatically. If the employee is a higher rate taxpayer, they can claim an additional £20 of tax relief (or £25 if they’re an additional rate taxpayer) by completing a Self-Assessment tax return, or by asking HMRC to adjust their PAYE code.

Net pay

Pension contributions under this system are deducted from gross pay, before tax and NICs are calculated. The term net pay is therefore confusing, as it refers to the point at which tax is calculated rather than when pension contributions are deducted.

In this way, full tax relief is provided at source regardless of what rate of tax the employee pays, meaning no further tax relief needs to be claimed separately by higher or additional rate taxpayers.

For an employee wishing to add £100 to their pension fund under net pay arrangements, their employer needs to deduct £100 from the employee’s gross pay and transfer it to their pension fund. That £100 does not suffer tax, so full relief is given at the time of making the contribution, regardless of whether the employee is a basic, higher or additional rate taxpayer. Employer and Employee NICs are still payable on the sum, as NICs are calculated based on gross salary.

Salary sacrifice

One of the ways in which employers can improve the tax position of pension contributions for them and their employees is to make the contributions via salary sacrifice.

Under salary sacrifice arrangements, an employee doesn’t make any contributions to the pension scheme themselves. Instead, they agree to give up the right to an amount of their salary in return for their employer making extra contributions to the pension scheme on their behalf.

To achieve a £100 contribution into their pension fund under salary sacrifice, the employee would need to agree with their employer to give up the right to £100 of salary in exchange for a £100 pension contribution. The employer then pays £100 into the employee’s pension fund, along with their normal employer contributions. In this case, there is a tax saving and also an NIC saving, as no Employer or Employee NICs need to be paid on the contribution.

Summary

Setting up a pension scheme and making sure the right employees are enrolled is a big obligation for employers, and important for the long-term financial security of employees. Employers have obligations from the moment they take on a new member of staff, so it’s definitely something to consider well in advance of recruitment.

Further resources

https://pensionawarenessday.com/

https://www.gov.uk/workplace-pensions-employers

https://www.litrg.org.uk/tax-guides/pensions

 

This article reflects the position at the date of publication shown above. If you are reading this at a later date you are advised to check that that position has not changed in the time since.  

We regularly publish articles on a range of tax and wider topical issues which affect employers. If you wish to subscribe to our monthly Employer Focus e-newsletter, please contact us.