Pension Contributions: Qualifying vs Total Earnings

Qualifying Earnings or Total Earnings for Pension Contributions

When setting up a workplace pension scheme, one of the most important decisions you'll make is how to calculate employee pension contributions. The two most common methods are qualifying earnings and total earnings, but which one is right for your business? Let’s break it down to help you make an informed choice.

What Are Qualifying Earnings?

Qualifying earnings are a specific band of an employee's salary that is used to calculate pension contributions. For the 2024/25 tax year, this band is set between £6,240 and £50,270 per year (before tax). Only earnings within this range are used to determine contributions.

Qualifying earnings include:

• Basic salary
• Bonuses
• Overtime
• Statutory payments (e.g., sick pay, maternity pay)

Example: If an employee earns £40,000 a year, only the portion of their salary between £6,240 and £40,000 will count towards their pension contributions.

What Are Total Earnings?

Total earnings, as the name suggests, include all earnings without restrictions or thresholds. This encompasses:

Total earnings include:

• The entire basic salary
• Bonuses
• Overtime
• Statutory payments

Example: If an employee earns £40,000 a year, their entire salary is considered when calculating pension contributions.

Pros and Cons of Each Approach

Qualifying Earnings Pros:

• Lower contribution amounts for both employers and employees, as only part of the salary is considered.
• Suitable for businesses managing tight budgets or those new to auto-enrolment.

Qualifying Earnings Cons:

• Can be more complex to calculate due to the specific earning band.
• Employees may save less for their retirement, which could affect long-term financial security.

Total Earnings Pros:

• Simpler to calculate, as all earnings are included.
• Employees benefit from higher contributions, potentially leading to a more comfortable retirement.
• Aligns with companies prioritising employee financial well-being.

Total Earnings Cons:

• Higher costs for employers and employees, as contributions are based on full earnings.

An Alternative Approach: Basic Pay

In addition to qualifying and total earnings, some businesses may consider the Basic Pay approach. This method calculates pension contributions based solely on an employee’s basic salary, excluding bonuses, overtime, and other variable earnings.

Pros of Basic Pay:

• Simpler calculations compared to qualifying earnings.
• Predictable costs for both employers and employees.

Cons of Basic Pay:

• Employees with significant variable earnings may save less towards their pension.
• May be perceived as less generous compared to total earnings.

Which Option Is Right for Your Business?

The best choice depends on your business goals and budget:

• If keeping costs down is a priority, qualifying earnings may be the better option.
• If you want to offer a competitive benefits package and support your employees’ long-term financial health, total earnings could be the way to go.

By weighing the pros and cons of all three approaches – qualifying earnings, total earnings, and Basic Pay – you can determine the best fit for your business goals and employee needs.

Frequently Asked Questions

1. Do I have to stick with one option? No, you can review and adjust your approach as your business evolves. However, changes should be clearly communicated to your employees.

2. Are there minimum contribution requirements? Yes. For qualifying earnings, the minimum combined contribution is 8% (employer minimum: 3%, employee minimum: 5%). For total earnings or other calculation methods, the percentages may vary depending on the scheme rules. However, these schemes must still meet or exceed the legal minimums required for auto-enrolment.

3. Can I offer different options for different employees? It’s possible but not common. Most businesses choose one consistent approach for simplicity and fairness.

4. How can I transition from one calculation method to another?

Transitioning from one method to another involves several steps:

• Consult Your Pension Provider: Ensure your chosen scheme supports the new calculation method.
• Communicate with Employees: Notify your staff about the change, explaining how it will impact their contributions.
• Update Payroll Systems: Work with your payroll provider to implement the new calculation rules.
• Certify Compliance: Confirm that the new approach meets legal auto-enrolment requirements.

Planning and clear communication will help make the transition smooth for both your business and employees.

Need Help Deciding?

Choosing between qualifying earnings and total earnings can feel daunting, but you don’t have to do it alone. At Penfold, we simplify pensions, so you can focus on growing your business.

Get in touch with us today to learn more about how we can support you and your employees on the journey to a comfortable later life.