Auto-Enrolment Pensions
Discussing automatic-enrolment pensions with clients and colleagues is one of the most time-intensive aspects of payroll administration. In practice, the initial pension setup usually requires decisions in two principal areas: the tax treatment of pension contributions and the basis on which pensionable pay is calculated. Once these settings have been implemented correctly, they typically require only limited ongoing intervention.
Tax Treatment of Pensions
In broad terms, there are three common approaches to the tax treatment of pension contributions.
Tax relief at source: Contributions are calculated on pensionable gross pay but deducted from net pay. The employee pays 80% of the intended contribution and the pension provider reclaims basic-rate tax relief from HMRC. In practical terms, a nominal 5% employee contribution will appear as a 4% deduction on the payslip. Read more.
Net pay arrangement: Contributions are deducted before income tax is calculated. This is unrelated to net pay terminology despite the name. Full tax relief is therefore obtained at the point of deduction, so a 5% employee contribution will appear as 5% on the payslip. National Insurance contributions are unaffected, which means pay subject to National Insurance may exceed pay subject to income tax.
Salary sacrifice: Strictly speaking, this is not a tax treatment of pension contributions but a contractual arrangement under which the employee agrees to a reduced salary in exchange for an increased employer pension contribution. The contribution is then made entirely by the employer. This approach can create additional legal, payroll, and employment considerations for both the employer and the employee. Where salary sacrifice is used, employers should also provide a suitable alternative for employees who cannot participate, for example, because of National Minimum Wage implications.
Calculation Basis of Pension
The basis on which pension contributions are calculated can also introduce significant complexity. For example, qualifying earnings can be particularly problematic in salary sacrifice arrangements. Although there is considerable flexibility in how pensionable pay is defined, maintaining compliance can be challenging.
Automatic-enrolment qualifying earnings: This is the statutory default. It applies to a band of earnings defined by the Department for Work and Pensions (DWP) and overseen by The Pensions Regulator. At present, the monthly band runs from £520 to £4,189 and is based on earnings subject to National Insurance. The statutory minimum total contribution is 8%, of which at least 3% must be paid by the employer.
Defined pay elements: This category covers alternative pensionable pay definitions. In practice, three common certification sets are typically used.
a. Set 1 – Pensionable gross pay, which does not necessarily need to include items such as bonuses. The minimum total contribution is 9%, with at least 4% from the employer.
b. Set 2 – At least 85% of pensionable gross earnings. The minimum total contribution is 8%, with at least 3% from the employer.
c. Set 3 – Total pay. The minimum total contribution is 7%, with at least 3% from the employer.
Qualifying Pension Schemes
Not all pension schemes can be used for automatic-enrolment purposes. This does not mean that such schemes are unsuitable in general; rather, a scheme must satisfy specific legislative requirements in order to qualify for automatic enrolment. If a worker participates in a non-qualifying scheme, they must still be assessed for automatic enrolment and, where required, enrolled into a qualifying arrangement. As a result, a worker could potentially be a member of more than one scheme.
Auto-Enrolment
The earlier sections of this article focus on pension scheme design, but automatic enrolment is a distinct compliance regime and should not be treated as synonymous with pensions generally. All employers are subject to automatic-enrolment legislation and must complete a declaration of compliance with The Pensions Regulator. This obligation applies even where no employees are currently eligible to be enrolled. Read more.
When is no Pension Scheme required?
In most cases, every employer will require a pension arrangement. However, there are limited circumstances in which an employer may not need a scheme immediately. These cases require careful analysis and may include the following:
All employees earn below the automatic-enrolment threshold: In this case, the employer may defer establishing a scheme until an employee exercises the right to opt in. However, the employer must still assess employees in every pay period and remain in a position to implement a qualifying scheme promptly if required.
Single-director payrolls: Where the only individual on the payroll is a director, that director may be exempt from automatic enrolment.
Other directors: The position can become more complex where there are multiple directors, as not every director will necessarily meet the statutory definition of a worker for automatic-enrolment purposes.
Foreign workers: Workers for whom the United Kingdom is not the usual place of work may be outside scope, although the rules are fact-specific and should be considered carefully.
Entirely exempt workforce: If the whole workforce is outside scope, the employer may declare the payroll exempt from automatic enrolment and notify The Pensions Regulator accordingly.
Exemptions should be applied with caution. The Pensions Regulator has made it clear that responsibility remains with the employer and cannot be outsourced.
The Auto-Enrolment Assessment
Although the legislation and guidance are extensive, the assessment is straightforward in many cases. There are four principal outcomes from an automatic-enrolment assessment:
Eligible: If the worker is not already a scheme member, has not previously opted out, and is not currently subject to postponement, they must be automatically enrolled.
Non-eligible: If the worker is not already enrolled, they may request to join the pension scheme. Where they do so, the employer must generally treat them in the same way as an eligible worker and make employer contributions.
Entitled: This worker may request to join a pension scheme, but the employer is not required to make contributions.
Outside automatic enrolment: This usually arises because the worker falls outside the relevant age criteria, for example an individual aged 80 who remains on payroll.
Some employers assess the full workforce in every pay run, while others assess only the relevant subset of workers, typically those who are not already scheme members and have not previously opted out. In practice, many employers treat entitled joiners and non-eligible joiners in the same way, particularly where the calculation basis is qualifying earnings.
Detailed assessment criteria are available elsewhere, but as a general guide a worker aged between 22 and State Pension Age who earns more than £833 per month (or £192 per week) will typically be eligible for automatic enrolment.
Postponements
Postponement allows an employer to defer the point at which a worker must be automatically enrolled, but it does not defer the employer’s statutory duties. A worker may still choose to join the pension scheme during the postponement period, and the maximum postponement period is three months. There are two main forms of postponement. Most providers support worker postponement, but some providers, such as Smart, do not support eligibility postponement.
Worker postponement: This is the simpler form of postponement and allows automatic enrolment to be delayed for up to three months from the worker’s start date. At the end of the postponement period, the worker will be enrolled if they are eligible.
Eligibility postponement: This can be more difficult for employees to understand but is often used for casual workers with variable earnings. A postponement period of up to three months begins when the worker first becomes eligible. If the worker remains eligible at the end of that period, they must be enrolled; if not, they are not enrolled and the process resets. A worker may experience multiple periods of eligibility postponement, although these cannot run consecutively.
Some employers choose to operate both forms of postponement, but in most cases a single approach is preferable. For salaried staff, worker postponement is generally the simpler option. It is also important to note that three months is the statutory maximum; a shorter period may be used, but it must not exceed that limit.
Opt-in or Opt-out
Workers also have certain choices in relation to pension scheme participation. In practice, postponements and opt-outs tend to create the greatest administrative complexity. Read more.
Opt-in: This arises where a worker chooses to join the scheme during a postponement period or because they are not eligible for automatic enrolment. They should ordinarily be enrolled in the next pay period after formal notice is given to either the employer or the scheme provider, depending on the provider’s process.
Opt-out: This occurs where a scheme member chooses to leave. If the member opts out within one month of joining, they are generally entitled to a refund of their own contributions. In practice, providers usually allow some flexibility because the employee must first receive confirmation that they have joined and instructions on how to leave. The term opt-out is often used more broadly, but after the initial one-month period the worker is technically ceasing active membership and will not normally be entitled to a refund. The phrase “opt-out window” refers to this initial one-month refund period.
Important: A worker cannot opt out of a pension scheme until they have become a member of that scheme. “Any decision to opt out must be taken freely by the staff member without influence from the employer.” The Pensions Regulator
For that reason, it is usually preferable for opt-out requests to be made directly to the pension provider rather than through the employer. The employer must not be seen to encourage or induce workers to opt out.
Other Items to Consider
Written notices: Various statutory communications may be required for automatic enrolment, and copies should be retained. One of the most important is the notice issued to a new worker explaining the assessment outcome, the pension position, and how the worker may opt in where relevant. Where salary sacrifice applies, additional information may also be required.
Contractual automatic enrolment:Although less common, it is possible in some cases to avoid ongoing assessment by enrolling workers through the terms of the employment contract.
Exceptions create most of the complexity:For most employers, the majority of workers will simply remain active members of the scheme. Administrative complexity tends to arise in relation to workers who are outside the scheme or who are receiving statutory payments.
Re-Enrolment: Every three years the employer undergoes re-enrolment and workers who were previously opted-out must be reassessed and potentially rejoin the scheme. The employer will also need to complete a declaration with The Pensions Regulator. Read more.
In Summary
Automatic enrolment and workplace pensions are technically complex, but there is extensive guidance available. Although the rules allow for a degree of flexibility, a simplified and well-controlled approach is usually the most effective for most employers. Worker postponement, in particular, is often a practical and administratively efficient option.