A costly pension underpayment error – check your payroll!

Running an efficient payroll can be complex. It became even more so from 2012, which is when employer pension contributions began to become compulsory via Auto Enrolment. Unfortunately, with greater complexity comes a greater risk of errors. This is something one employer discovered thanks to a costly pension underpayment error. As you’ll see, keeping a close eye on your payroll is more important than ever!

What’s the story behind the pension underpayment error?

The story behind the pension underpayment error is innocuous enough. However, to understand what happened, you need to be familiar with how tax relief operates for workplace pension schemes. These schemes use one of two methods of tax relief in relation to employees’ pension contributions, currently set at 5%.

The first method is known as Relief at Source (RAS). This works by taking a 4% contribution from an employee’s net pay. In other words, the money is deducted after PAYE tax and NI have been deducted. The pension scheme then recovers the extra 1% of tax relief from HMRC. This is then added to the pension fund, giving a total pension contribution of 5%.

The second method of tax relief is the Net Pay Scheme (NPS). Under this, the employee pension contribution is deducted from their gross pay. This means that tax relief is given through the payroll. As a result, the pension scheme doesn’t need to claim anything from HMRC.

How did the pension underpayment error happen?

You’ve probably guessed that the pension underpayment error happened because of a confusion between the two schemes. What happened was that the employer’s payroll was processed under Relief at Source. Unfortunately, the pension records determined it should have been subject to the Net Pay Scheme.

The problem came to light because an employee asked why their pension scheme wasn’t receiving the correct tax relief uplift.

The employer then looked into the problem. This is when they discovered they were using RAS instead of NPS. Worse still, they discovered that – by using the wrong method – they were breaching the employers’ minimum legal pension contribution requirement.

What happened next?

What happened next was very expensive for the employer. They were forced to top up all pension pots for current and former employees with the additional 1% contribution. This had to be backdated for a number of years.

In addition, the employer had to top up pension pots to take into account the extra growth that the extra payments would have delivered. Ouch!

Could you weather a pension underpayment error?

For some employers, mixing up the two different methods of tax relief could have proved fatal to their business. So, it’s worth asking yourself whether you could weather a pension underpayment error of this kind. Certainly, now is a good time to double check that your payroll and pension schemes are operating correctly

One way to minimise pension errors is to make sure you get good employers’ pension advice. The other is to outsource your payroll. THP’s payroll outsourcing service can handle relevant pension payments for you and we’ll make frequent checks everything is running correctly, giving you peace of mind. To learn more, talk to one of our friendly payroll experts today.