The vital role of pensionable pay

It’s essential every business has an understanding of pensionable pay.

In short, pensionable pay is the “slice” of staff income you use to calculate your company’s contribution to each employee’s pension.

This slice can potentially include everything your staff member receives on a wage slip – from basic salary to commission and sick pay.

However, when setting up a pension, you need to think of another factor: percentage. What percentage of this pensionable pay do you want to use to calculate your business’s pension contribution?

It’s a complex task, but The Pensions Regulator has effectively created a menu which gives your business a greater choice of what you want to put into a pension calculation. However, it demands an eye for detail and a mind for math.

An important decision

Of course, whatever you choose affects your bottom line. Get it wrong, and you could put an unnecessary hole in your finances… and make your business less attractive to employees, as your contribution effectively decides theirs. Remember this when deciding what percentage your company wants to use to calculate your contribution: when the scales tip in your company’s favour, they go against the employee.

So, what are the different types of pensionable pay? How do they work in terms of percentages used in pension contributions?

Qualifying Earnings

Qualifying Earnings is the most widely used pensionable pay arrangement. It is known by some as “banded earnings”, and it’s popular in part because strict thresholds stop your pension contributions from getting out of control.

So how does it work? A “higher” and “lower” threshold is set on employee income for a given tax year, and only staff pay within these boundaries is taken into account. This year, that annual income is £6,240 to £50,270. But Qualifying Earnings does take all types of income into consideration, including:

• salary
• wages
• commission
• bonuses
• overtime
• statutory sick pay
• statutory maternity pay
• ordinary or additional statutory paternity pay
• statutory adoption pay

The next consideration is percentage. So, what proportion of this money goes into your staff member’s pension calculation? With Qualifying Earnings, you put in a minimum of 3% equivalent of this money, your staff member 5% out of their wage, and the rest is tax relief.

What other choices does your business have?

The Pensions Regulator has implemented three other “sets” of pensionable pay. Each of these gives the employer choice over how much staff pay is taken into a pension calculation – and what equivalent percentage of this they contribute as part of a pension payment calculation.

It is worth noting that the total amounts are not “banded”, however, so they don’t offer that same type of protection for your business.

Set 1

With Set 1, pensionable pay is based on a staff member’s basic salary, so this excludes bonus, overtime, and commission. It is worth remembering, however, that basic salary does include things like holiday pay and statutory payments (e.g. sick pay and maternity pay).

This is different from Qualifying Earnings because it only includes one pay type, and like the other Sets we’ll discuss, it doesn’t have thresholds. In this Set, you, the employer, contribute 4% based on basic salary, and your employee puts in 5%. This means a higher percentage for the employer than with Qualifying Earnings, but it is based on a potentially smaller segment of pay.

What does this imply?

One thing quickly becomes clear for these alternative Sets: there’s a balancing act based on how much money is taken into account versus the percentage used for the pension calculation.

If you have staff who are heavily paid through commission or bonuses, Set 1 might make more sense because although you are paying a contribution based on 4% of basic pay (not 3% as with Qualifying Earnings), you might then be taking into account less money overall.

Set 2

As another option, employers might want to take into account Set 2. With Set 2, pensionable salary is the same as Set 1 – however, if the total pensionable salary of all workers does not meet 85% of their salary, then other elements of pay (such as overtime) can be included to make it up to this figure. In terms of percentage, you would put in 3% as the employer, and your staff member would pay 5%.

Set 3

With Set 3, the pensionable salary includes all earnings. The employer outgoings are 3%, and the employee pays 4%, the latter being less than in Sets 1 and 2. The pitfall here is that because it takes all money into account, the percentages could come to more than in Set 1, 2 and Qualifying Earnings.

A word of caution

Choice, generally speaking, is good. But in finance, choice always comes with a margin for error that could needlessly cost you money.

For instance, you could go for Set 3 for the lower percentage contribution, but what if staff suddenly get pay raises and promotions – or a big bonus? Thinking ahead could make Set 3 less attractive than Sets 1 and 2.

Also, the different Sets come with extra responsibility: you have to produce a certificate every 18 months (this needs to be kept on your files and retained for 6 years). It doesn’t have to be sent away, but it does have to be kept to hand. You can run into trouble if you fail to produce this easy-to-overlook paperwork for The Pensions Regulator.

That’s not the only obligation. If the terms suddenly look less favourable, you can switch over to a different pension Set or Qualifying Earnings. But with that comes the danger that you have caused a breach: as Sets 1, 2 and 3 are part of a contractual arrangement with the employee. In those situations, a need for an accountant might change into a need for a lawyer.

Not sure which to choose?

Dataplan is always here to help. We can look at what is working, what isn’t and if you are currently meeting your obligations.

Contact us to find out more.