Chapter 8: Pension contributions, 2014 edition

Most member and employer contributions to private pensions are made as a percentage of the employee’s pay. Such contributions, along with fixed amount payments, can be made as part of a schedule of normal (or regular) contributions. Members may also choose to make additional contributions to their private pension. Both of these types of contributions are considered within this chapter. When special cash payments are made to schemes (for example to address a deficit in a defined benefit schemes’ liabilities), these payments are not considered normal contributions. Information on such payments are not considered in this chapter.

The level of contributions alone does not provide a measure of pension adequacy. In Defined Contribution (DC) schemes, also known as money purchase schemes, the pension is determined by the level of contributions, the investment returns received while the contributions are invested in a pension fund and, if an annuity is purchased, by the annuity market (see Defined Contribution pension savings). In Defined Benefit (DB) schemes, the scheme rules determine the amount of pension that will be received in retirement, based on the accrual rate, length of service and salary. (For definitions, see Pension Trends Glossary (198.9 Kb Pdf). For information regarding membership of all types of non-state pension see Pension Trends Chapter 7.)

There is considerable variation in the level of contributions between schemes, and in employer and employee contributions. At one extreme, employers bear the whole cost of running the pension scheme. These schemes are called non-contributory as their members pay no contributions. At the other end of the spectrum, there are pensions where the employer makes no contribution and the full cost of pension saving is carried by the individual. These are personal pensions.

Based on average contribution rates, around three-quarters of the cost of private sector DB occupational pension schemes falls on the employer. With DC occupational pension schemes, the employer makes around two-thirds of total contributions.

The amount an employer contributes to a private sector DB pension scheme can vary and is usually based on actuarial estimates of the fund required to meet payments of scheme benefits (see Pension Trends Chapter 9). In the 1990s, when the strong equity market led to significant growth in fund values, some employers took contribution holidays to reduce pension fund surpluses. In contrast, the global economic downturn in the early 21st century meant that some pension schemes went into deficit and employers had to make additional special contributions.

Starting in October 2012, with gradual roll out by 2018, all employers have a duty automatically to enrol eligible employees into a qualifying pension scheme and to make contributions on their behalf. Automatic enrolment is being introduced in stages, based on the size of the employers’ Pay As You Earn (PAYE) scheme on 1 April 2012, commencing with the larger employers. Minimum workplace pension contribution levels for employers have also been introduced, in a phased process, again with full implementation by 2018.

The minimum contribution levels vary depending upon the scheme’s definition of pensionable pay. In the case of a scheme with a definition of pensionable pay equivalent to that of qualifying earnings¹, the minimum level of contributions, expressed as a proportion of the employees’ qualifying earnings, are as follows:

• between October 2012 and September 2017 Defined Contribution (DC) schemes or personal pensions must have contributions of at least 2%, with at least 1% coming from the employer;

• between October 2017 to September 2018 the minimum contribution will be 5%, with at least 2% coming from the employer; and

• from October 2018 it will be 8%, with at least 3% coming from the employer.

It should be noted that workplace pension reforms are not taking place in isolation. Other reforms, (for example, state pension reform, see section: Contracting out of private sector workplace pension schemes) and other factors, such as the use of salary sacrifice arrangements², employment levels, disposable household income levels and attitudes to saving for retirement, may all affect contribution rates

For more detailed information on workplace pension reforms and links to further information please see Supporting information: Workplace pension reforms.

Notes for workplace pension reforms

1. Qualifying earnings refer to earnings between £5,668 to £41,450 in 2013/14. Qualifying earnings include earnings from bonuses and overtime. Some pension scheme rules do not include these items in their definition of pensionable pay.

2. Employer contributions levels can be affected by salary sacrifice arrangements whereby higher contributions are made by the employer with the member in return accepting a lower rate of pay. Where such arrangements exist, the member and employer both benefit from lower National Insurance payments.

The various data sources used in this chapter have different coverage and characteristics. The analyses use the source that is most appropriate for the topic, but this inevitably means that there are differences in the types of pension covered and in the population base between one analysis and another. The main sources used are:

• the Office for National Statistics (ONS) Occupational Pension Schemes Survey (OPSS), for estimating numbers of active members of occupational pension schemes, average contribution rates and the distribution of employee and employer contribution rates in occupational schemes;

• the ONS Annual Survey of Hours and Earnings (ASHE), for the distribution of employee and employer contribution rates for workplace pensions; and

• HM Revenue and Customs administrative data for the number and size of contributions to personal pensions.

The OPSS collects regular contribution rates, excluding fixed amount payments, but can also identify the proportion of members in schemes with fixed amount payments. In ASHE, contributions include one-off fixed amount payments from either the employee or employer. Both ASHE and OPSS exclude additional voluntary contributions (AVC’s) made by employees, and employer contributions which cover more than one employee, for example, deficit reduction payments to a scheme.

The reference date for the 2013 estimates from the OPSS and ASHE is April 2013. The 2013 results are the first estimates to be produced from these surveys following the introduction of the Workplace pension reforms. While reference is made to these reforms within the chapter, it should be noted that the phased implementation of the reforms was at an early stage in April 2013.

Caution should be exercised when interpreting changes in estimates of average contribution rates over time. Changes over time may reflect variation in sample estimates rather than significant shifts in contributions rates. Quality and methodology information is available on the ONS website for the OPSS (354.5 Kb Pdf) and ASHE (212.6 Kb Pdf), both of which are designated as National Statistics in accordance with the Statistics and Registration Service Act 2007.

On average, regular contribution rates (excluding fixed amount payments) are higher for Defined Benefit (DB) schemes than for Defined Contribution (DC) schemes. The 2013 Occupational Pension Schemes Survey (OPSS) found that the average total contribution rate (employee plus employer contributions) for private sector DB occupational pension schemes was 20.6%, while for DC schemes it was 9.1%.

Table 8.1 shows weighted-average contribution rates since 2000, for the years for which data are available from the OPSS. Between 2011 and 2013, employer contribution rates for DB schemes have risen slightly, from 14.2% to 15.4%. It may be that schemes increase their regular contribution rates in order to minimise deficits or the risk of falling into deficit. Pension Protection Fund (PPF) estimates of DB schemes liabilities have increased over the last few years (Table 4.2 of the Purple Book 2014), suggesting schemes may need to consider raising regular contribution rates.

The recent fall in average employer contribution rates for DC schemes, from 6.6% in 2012 to 6.1% in 2013, may be linked to the impact of workplace pension reforms. Whilst it is not possible to isolate the effect of these reforms, an increase in the number of new members starting pensions on the minimum contribution rates would lower the average rate. The fall may also be due to employers reducing contributions into existing pensions, referred to as ‘levelling down’. Analysis conducted by the Department of Work and Pensions (DWP) suggests the incidence of ‘levelling down’ has remained at a level consistent with that found before the introduction of automatic enrolment.

Changes in contributions over time can also be examined by looking at the distribution of active members (or employees) across contribution rate bands. It should be noted that some of the changes in the distribution of members across contribution bands reflect underlying changes, such as the shift in membership from DB to DC schemes (see Pension Trends Chapter 7) or changes to the ability of schemes to contract out of the additional state pension (see section Contracting out of private sector occupational pension schemes). The following sections look at the distribution of employee and employer contribution rates.

Employee contribution rates for private sector occupational pension schemes

This section looks at employee contribution rates for private sector occupational Defined Benefit (DB) and Defined Contribution (DC) schemes with 12 or more members. In 2013, according to results from the OPSS, an employee in a private sector occupational DB scheme contributed, on average, 5.2% of salary. For occupational DC schemes, the average contribution rate was 2.9%. The average contribution rate for employees in private sector occupational DB schemes, was estimated to have increased from 2000 to 2009, fell to 4.9% by 2012 but then increased to 5.2% in 2013. For occupational DC schemes, there has been little change in employee contribution rates (Table 8.1).

The total number of active members of private sector occupational pension schemes fell from 6.3 million in 1991 to 2.7 million in 2012 then increasing to 2.8 million in 2013 (For information about private pension membership see Pension Trends Chapter 7). These figures exclude very small schemes (with fewer than 12 members) as data on contribution rates are less robust for such schemes and they account for only a small amount of private sector occupational pension scheme membership, 0.1 million members in 2013. The estimates provided in this section also exclude those that did not provide information on their contribution rates, around 0.1 million members in 2013.

Table 8.2 shows information from OPSS on the proportion of employees within each employee contribution rate band. For 2013, the proportion of members in the lowest contribution band (under 3%) was around 9% of the total, 3 percentage points higher than in 2012. The proportion of active members in the highest contribution band increased from just under 22% in 1991 to over 42% in 2009 but then fell to just under 35% by 2013.

Figure 8.3 shows the breakdown of DB and DC employee contribution rates by bands for 2009 to 2013. For DB schemes, the most common rate for employee contributions was ‘6% and over’. This band represented 60% of active members in 2013. Contribution rates were generally lower for DC schemes. Tthe most common rate for DC employee contributions was ’3% to 4%’. This band represented around 25% of active members in 2013. This difference might be explained by the different characteristics of DB and DC schemes. For DB schemes, the level of contributions employees (and employers) make is based on actuarial estimates of the amount of money required to meet the promised level of pension payment to all scheme members on retirement. For DC schemes, no promise regarding the level of pension payment that will be received by members in retirement is made.

Between 2012 and 2013, the proportion of employee members of DC schemes contributing ‘Under 2%’ increased from 3% to 12%. This may be, in part, due to the impact of the workplace pension reforms, with new members starting DC pensions in 2013 as a result of automatic enrolment potentially making only the minimum contributions required.

Employer contribution rates for private sector occupational pension schemes

In this section, we look at employers’ regular contribution rates using results from the OPSS. The data excludes additional contributions paid as fixed amounts though additional contributions can be substantial where employers are correcting deficits in DB schemes.

There is a marked difference between employer contribution rates in DB and DC pension schemes. In 2013, the average employer contribution rate for private sector DB occupational pension schemes was 15.4% of salary. This compares with an average employer contribution rate of 6.1% for DC schemes (see Table 8.1). Part of the difference between contribution rates in DB and DC schemes is attributable to the different characteristics of the schemes and their members:

• DC occupational pension schemes can no longer contract out of the additional state pension. The Pensions Act 2007 abolished the option for DC pensions to contract out with effect from April 2012. Even prior to this, most DC occupational schemes were not contracted out. Most DB occupational schemes are contracted out (see section Contracting out of private sector occupational pension schemes);

• most DC schemes are not as long established as DB schemes. As DB pension schemes membership matures, it is possible higher contribution rates are more likely in order that the schemes can meet their liability to these members (for more information see Pension Trends Chapter 6).

The distribution of active membership by level of employer contributions is shown in Figure 8.4. In 2013, 71% of active members of private sector DB schemes had employer contributions of 12% of salary or more. The proportion with employer contribution rates of ’15% and over’ fell from just below 58% in 2012 to just below 50% in 2013. Whilst, as stated previously, it is not possible to isolate the effect of workplace pension reforms, the lower proportion in the ‘15% and over’ band in 2013, may reflect an increase in the number of employees being automatically enrolled into existing DB pension schemes with employer contributions in the lower contribution bands. It may also reflect employers reducing contributions into existing pensions.

Only 4% of active members of DC schemes were in the ’15% and over’ employer contribution rate band in 2013. The proportion of DC schemes with employer contribution rates of ‘Under 4%’ increased from around 11% in 2012 to almost 22% in 2013. This increase may reflect an increase in the number of employees starting new pensions on the minimum contribution rates required under automatic enrolment.

Contracting out of private sector occupational pension schemes

The Pensions Act 2007 abolished the option for Defined Contribution (DC) pensions to contract out of the additional state pension, from April 2012. Contracting out for Defined Benefit (DB) schemes will also end with the planned introduction of the single-tier pension in April 2016. In 2013, 1.3 million members, 80% of all active members of private sector DB schemes, belonged to contracted out schemes.

Employers contributing to schemes that are not contracted out pay higher National Insurance contributions that will deliver benefits in the form of additional state pension for their employees. Employers contributing to contracted out schemes make lower National Insurance contributions, with the pension benefit from the scheme expected to make up for the loss of any additional state pension that could have potentially been accrued. It is reasonable to expect that employer contributions made to contracted out pension schemes will be higher than those made to not contracted out pension schemes.

The data would seem to support this. In contracted out DB schemes, 93% of active members received contribution rates of 8% and over and 53% received 15% and over. This contrasted with not contracted out DC schemes, where 49% of active members received employer contribution rates of less than 8% in 2013.

OPSS estimates that the employer contribution rate for contracted out DB schemes in 2013 was, on average, 16.4% . For not contracted out DB schemes the rate was 11.5%, for not contracted out DC schemes the rate was 6.1% (these estimates are available in the download file for Table 8.5).

The relatively low employer contribution rates of DC schemes might be partially explained by all DC schemes being not contracted out, from April 2012. If this were the case, then it would be expected that, before that, such DC schemes would have employer contribution rates similar to those of contracted out DB schemes. Historically, the data has shown that, to some extent, this is the case. The download file for Table 8.5 gives the historical data¹. However, the ‘not contracted out’ status of DC schemes does not fully explain their lower employer contribution rates.

Contributions to private sector occupational Defined Contribution (DC) pensions

This section looks at total (employer + employee) contribution rates to occupational ‘not contracted out’ DC schemes by various factors such as age, sex, occupation and earnings².

Data from ASHE is used. ASHE is a good source of data on contribution patterns because it collects information for employees, whereas OPSS collects information for schemes. However, it should be noted that it is not possible to compare average contribution rates from ASHE with those from OPSS. This is because ASHE potentially includes small numbers of individuals making large one off fixed amount contributions (see section Data sources), while the OPSS figures are based on regular contributions made as a percentage of salary only.

Table 8.6 shows the distribution of employee members of private sector ‘not contracted out’ DC schemes by total contribution rates for each year between 2009 and 2013. The estimates show a slight shift to higher total contribution rates from 2009 to 2012. For example, in 2009, 32% of members were in receipt of contributions of less than 8% with 37% in receipt of contributions of 12% or more. By 2012, 25% of members were receiving less than 8% and over 44% were receiving contributions of 12% or more.

In 2013, following the introduction of automatic enrolment and the end to the possibility of contracting out for DC schemes, 32% of members were receiving contributions of less than 8% and 16% received contributions of under 4%. In 2013, 41% were receiving contributions of 12% or more.

Figure 8.7 shows modest differences in total contribution rates between male and female employees in DC occupational pension schemes not contracted out of the additional state pension. In 2013, as in most previous years, the most common contribution rate for men and women was ‘8% to under 12%’ of earnings. A higher proportion of women contributed in the ‘Greater than 0 and under 4%’ band; and in all bands from ‘16% to under 20%’ and above.

As employees approach retirement they may wish to increase their pension contributions to try to improve their retirement benefits, if this option is offered as part of the scheme rules³. If members increase contributions as they approach retirement we would expect to see a relatively high proportion of older members in the higher contribution bands. Figure 8.8 shows some evidence of this for DC schemes in 2013. The older age groups represent a greater proportion than the younger ones in most of the higher contribution bands (16% and over); and the younger age groups represent a greater proportion than the older ones in the lower contribution bands, in particular the 4-8% band.

The contribution rates reported for different age bands might reflect a ‘cohort effect’ rather than, or as well as, contribution patterns over individual lifetimes. In other words, they may show that many older workers benefited from higher total contribution rates over their working lives because they joined their pension schemes earlier, when regular contribution rates might have been higher. We cannot establish whether such an effect exists, as the data on contribution rates is not available before 2005.

Managers and senior officials had the highest total contribution rates: 33% had total contributions of 16% or more in 2013, and only 20% had total contributions of less than 8%.

The impact of different earnings levels is shown in Table 8.10. As in previous years, in 2013 employees with higher earnings tended to have higher total pension contribution rates. Just over 50% of employees earning over £600 per week had total contribution rates of 12% of earnings or more. In contrast, nearly 60% of employees earning under £200 per week had rates of less than 12% of earnings.

Notes for private sector occupational pension contribution rates

1. In 2013, all active members of Defined Contribution (DC) schemes are by law, not contracted out. In 2011, prior to the implementation of this legislation, there were still only 0.1 million active members of ‘contracted out’ DC schemes. This relatively small figure made it difficult to compare the proportions in each contribution band with the distribution of active members in contracted out Defined Benefit (DB) schemes.

2. The Annual Survey of Hours and Earnings 2013 pension tables, in particular tables P6 to P12, show the proportion of employees by employee and employer contribution rate bands for the other pension types.

3. In 2013, OPSS asked the larger defined contribution schemes (those with 12 or more members) the question “Are the normal contributions to the scheme made at variable rates that depend on the member’s age?" 15% of active members were in schemes that said yes.

Nearly all public sector occupational pension schemes are Defined Benefit (DB) schemes. The majority of membership is in the seven big public sector employers: the civil service, the armed forces, the National Health Service (NHS), teachers, local government (the Local Government Pension Scheme), police and fire-fighters. Apart from the Local Government Pension Scheme, which is funded, all of these schemes are run on an unfunded basis (see Pension Trends Glossary (198.9 Kb Pdf)). In the Annual Survey of Hours and Earnings (ASHE), the public sector is classified using the legal status from the Inter-Departmental Business Register.

Since 2011, many public sector pension schemes have made changes to their employee contribution rates. These have been made as a result of recommendations outlined in the 2011 report of the Independent Public Service Pensions Commission chaired by Lord Hutton of Furness. In general, these changes have led to increased contribution rates at all levels. Many schemes have introduced, or were already using, tiered structures where the contribution rate is determined by the employee’s earnings band.

Figure 8.11 shows that, in 2011, 11% of employees were paying contribution rates in the ‘7% and over’ band, with 47% paying ‘6% to under 7%’. Employee contribution rates had increased by 2013, with 38% paying contributions in the ‘7% and over’ band and 22% paying ‘6% to under 7%’.

Employer contributions to unfunded public sector pension schemes are largely an internal accounting transaction within government. For most of these schemes, the level of contributions is estimated using a model known as SCAPE (Superannuation Contribution Adjusted for Past Experience). The model estimates the level of contributions which will be sufficient, over time, to cover the scheme’s liabilities.

Personal pensions, which include stakeholder pensions and Self-Invested Personal Pensions (SIPPs)¹, are those where individuals enter into a contract with a pension provider, usually an insurance company (by contrast, occupational schemes have trustees and are governed by trust law, see Pension Trends Glossary (198.9 Kb Pdf)). Personal pensions may be taken out on an individual basis or arranged on a ‘group’ basis, usually facilitated by employers, who may make contributions for members. Employers may use ‘group’ personal pensions to meet their obligations under Automatic Enrolment (AE).

Employer contributions to personal pensions

Some employers operate Group Personal Pensions (GPPs) either as well as an occupational pension scheme or as the main form of pension provision. The GPP’s employers operate may include group stakeholder pensions and group self-invested personal pensions. Although the employees contributing to GPPs have individual contracts, the administration costs are likely to be lower than if they arranged an individual personal pension independently.

One of the reasons behind the introduction of stakeholder pensions in 2001 was to improve pension provision for people working for small employers. Small employers had been unable to provide the more traditional form of occupational pension scheme for cost reasons, but stakeholder pensions are a relatively low-cost type of scheme. Due to the staged nature of AE, at April 2013, the reference date of the ASHE, only larger employers needed to have introduced AE and to be making the associated minimum contributions (see section: Workplace Pension Reforms). Therefore, it is of interest to examine employer contribution rates to GPPs (including group SIPPs) and stakeholder pensions specifically, by size of employer.

Figures 8.12 and 8.13 show the proportion of GPP and stakeholder pension members by employer contribution rate for private sector employers in 2013, for employers:

• with fewer than 100 employees (Figure 8.12); and

• with 100 or more employees (Figure 8.13).

The charts show a clear difference. In smaller employers, 34% of those with GPPs and 25% of those with stakeholder pensions had employer contribution rates of 6% and over. For larger employers, 43% of those with GPPs and 38% of those with stakeholder pensions had employer contribution rates of 6% and over.

In larger employers (Figure 8.13), 4% of those with GPPs and 5% of those with stakeholder pensions received no employer contribution in 2013; this compares with 5% and 9 % respectively for smaller employers (Figure 8.12).

Total contributions to personal pensions

Her Majesty’s Revenue and Customs (HMRC) publishes estimates of the number of people making contributions to personal and stakeholder pensions and average amounts contributed. All estimates of contributions are in nominal terms (values are not adjusted for inflation).

In 2012/13, the total number of individuals making contributions to personal and stakeholder pensions (whether individual or group personal pensions) was estimated to be 5.5 million. Of those, 4.9 million were employees, 0.5 million were self-employed people and around 0.06 million (60,000) were ‘others’ (children, people in full-time education, carers, the unemployed and those in receipt of a pension). There were more people contributing in 2012/13 than in 2011/12 (see HMRC Table PEN3). The average contribution per person was lower in 2012/13 (£3,510) than in 2011/12. For employees, the average contribution in 2012/13 was £3,490, down from £3,640 in 2011/12. For the self-employed, the average contribution was £3,760 in 2012/13, down from £4,250 in 2011/12.

For the self-employed, individual personal and stakeholder pensions are the main options for private pension saving. The self-employed may also join some master trusts (see Pension Trends Glossary (198.9 Kb Pdf) ). The self-employed also rely more on private pensions than employees as they do not have access to the additional state pension.

The total value of contributions paid into personal and stakeholder pensions, Retirement Annuity Contracts (RACs) and Freestanding Additional Voluntary Contributions (FSAVCs) is shown in Figure 8.14 (for definitions see Pension Trends Glossary (198.9 Kb Pdf) ). Contributions to personal and stakeholder pensions consist of minimum contributions and contributions by employers and individuals (employees, the self-employed and non-earners). The figures include contributions to employer and non-employer sponsored personal pensions. Minimum contributions represent the rebate paid by HMRC to individuals who have used their personal or stakeholder pension to contract out of the additional state pension. Personal and stakeholder pensions are flexible, allowing people to make contributions when they are able. Total contributions to personal and stakeholder pensions, RACs and FSAVCs reached £20.9 billion in 2007/08, but then fell during the recession, largely due to the fall in the number of people contributing to personal and stakeholder pensions. By 2011/12, they had increased to £19.9 billion, falling to £19.5 billion in 2012/13.

Employer contributions to personal and stakeholder pensions have seen increases in most years, reaching £9.9 billion in 2012/13 compared with £0.5 billion in 1990/91. On the other hand, individuals’ contributions rose from £1.5 billion in 1990/91 to £10.2 billion in 2007/08, but then fell during the recession to £9.0 billion in 2008/09, £7.8 billion in 2009/10 and £7.7 billion in 2010/11. In 2011/12, they had increased to £8.7 billion but then fell to £7.7 billion in 2012/13.

FSAVCs can be made by members of occupational schemes. The decline since 1999/2000 is because many have chosen to save through stakeholder pensions rather than FSAVCs, partly because the administration costs are lower and partly because stakeholder pensions provide a more flexible method of saving. From 6 April 2006, FSAVCs are no longer separately identified and are included in individuals’ contributions.

Minimum contributions reached £3.6 billion in 2003/04. By 2012/13 the level of minimum contributions, which represent contracted out rebates to individuals in contracted out schemes, was much lower at £1.6 billion. This is as may be expected given the ending of the ability to contract out (see section Contracting out of private sector occupational pension schemes).

Notes for personal pensions

1. Available since 2001, stakeholder pensions are a flexible, portable, personal pension arrangement (provided by insurance companies) with capped management charges. They must meet the conditions set out in the Welfare Reform and Pensions Act 1999 and be registered with The Pensions Regulator. Self-invested personal pensions are a type of pension in which the policy holder rather than the pension company chooses the investments made.