For employers, determining the contributions to a workplace pension scheme depends on the pensionable earnings of their employees. This article will explain the different methods for calculating pensionable earnings and how these methods affect pension contributions and tax efficiency.
Explaining pensionable earnings
Pensionable earnings are crucial for employers in determining the amount to be paid into their employees pensions. It is the portion of the employee’s salary that is used to determine the pension contribution.
The term ‘qualifying earnings’ is often used when discussing employer pension contributions, however it is just one way of calculating pensionable earnings.
At present, both companies and employees must contribute a minimum of 8% of pensionable earnings to an auto-enrolment pension scheme, split 3% from the employer, 4% from the employee and 1% as tax relief.
Methods for calculating pensionable earnings
Three methods can be used to calculate the portion of an employee’s earnings eligible for employer pension contributions:
- Basic pay
- Qualifying earnings
- Total earnings
The contribution figures for employers and employees will differ based on the chosen method for calculating pensionable earnings. Any of these approaches can be adopted as they are all officially approved by HMRC.
Basic pay method
This method involves using the employee’s base salary or wages, inclusive of holiday pay, but excluding additional earnings like overtime or bonuses.
Qualifying earnings method
Commonly used for defined benefit pension schemes, qualifying earnings are applicable only to the portion of an employee’s earnings ranging from £6,240 to £50,270. This may include:
- salary/wages
- bonuses
- commission
- overtime
- statutory sick pay
- statutory parental leave
Total earnings method
This method includes all income earned in employment, except dividend payments. It encompasses all the additional earnings mentioned above.
Examples of pensionable earnings calculations
The examples below illustrate how each approach affects the total employer contributions. Consider an employee with an annual salary of £38,000 and a £2,000 bonus.
Basic pay (bonus is not considered):
- Bonus excluded
- Pensionable earnings £38,000
- Employer contribution: £1,140
- Employee contribution (inc. tax relief): £1,900
- Total contribution: £3,040
Qualifying earnings (£6,240 is deducted from total earnings of £40,000):
- Bonus included
- Pensionable earnings £33,760
- Employer contribution: £1,012.80
- Employee contribution (inc. tax relief): £1,688
- Total contribution: £2,700.80
Total earnings:
- Bonus included
- Pensionable earnings £40,000
- Employer contribution: £1,200
- Employee contribution (inc. tax relief): £2,000
- Total contribution: £3,200
For contributions made to a workplace pension scheme using a net pay approach (before tax), the tax on earnings will be calculated on the lower amount. This means that neither income tax nor National Insurance will be paid on your pension contributions. Opting for a salary sacrifice pension scheme could further minimise tax obligations.
Managing your workplace pension scheme
Regardless of whether you choose the basic pay, qualifying earnings, or total earnings method, it is essential to ensure that your calculation method is compatible with your payroll software.
Penfold’s workplace pension makes things easy. Help with pensionable earnings is only ever a phone call away with dedicated 1-2-1 account management.
See how businesses are providing great pension experiences for thousands of employees. Book a demo of Penfold today.
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