Coronavirus Job Retention Scheme: how could furloughing affect your pension?

Furlough refers to employees who are temporarily stood down by their employer because they are unable to work as normal but they remain on the payroll as an alternative to being made redundant.

As a result, the Government has announced the introduction of the Coronavirus Job Retention Scheme (JRS). With many employers under huge financial strain, the JRS will pay 80% of an employee’s salary capped at £2,500 per month for up to three months.

As an employee, this reduction in salary leads to a reduction in pension contributions – as contributions are typically a percentage of salary – which without careful planning now, could ultimately affect your retirement plans significantly.

As an employer, without following the set and at times complex government rules on employees’ contributions, this could lead to breaches in contract and potentially large fines.

Pension contributions and furloughing – what we know so far

While we do not yet have the complete picture about furloughing and its impact on pension contributions, we are expecting guidance from the Government, HMRC and the Pensions Regulator soon.

In the meantime here is a summary of what we know.

Defined Contribution (DC) Schemes

• The Government will only pay the auto enrolment minimum employer pension contribution, i.e. 3% on the 80% or £2,500 per month if lower, of the employee’s regular monthly wage (no commission, fees or bonus are included). If the employer pays more than this, the JRS only covers 3% of the furloughed salary as an employer contribution. Employer National Insurance contributions (NICs) on the furlough salary are also payable.
• The JRS will not cover the employees’ auto enrolment pension contributions at all.
• For members who are part of a salary sacrifice scheme, the 80% pay is based on the employee’s reduced (post sacrifice) salary and the JRS will only cover 3% of qualifying earnings based on an employee’s gross furlough salary.
• The 3% itself is based on 3% of earnings above the lower qualifying earnings threshold (£520 for the 2020/21 tax year) up to the monthly limit of £2,500. This is the case regardless of the definition of pensionable earnings used by the employer for auto enrolment and regardless of which quality test is used for auto enrolment.

For example, if an employee usually earned £2,500 a month and received a 5% employer pension contribution on their full wage (i.e. £125.00), the Government via the JRS would pay £2,000 in respect of the salary and 3% of (£2,000 - £520) = £44.40 in respect of the employer pension contribution. Employer NICs of 13.8% x (£2,000 - £732, the secondary threshold) = £174.98 would also be covered.

We understand that the legal position currently is that the employer must top up any difference in contribution rates if it is furloughing. If the employer is not prepared to do so, then this amounts to a listed change as it is a change to its pension contribution structure. This then requires the employer, if it has 50 or more employees, to consult for 60 days before changing its pension contribution structure. This is just a consultation and individual consents are not required.

The Pensions Regulator has the power to issue a £50,000 fine if the employer fails to satisfy its statutory 60 day pension consultation obligations.

However, we understand that the Pensions Regulator is looking at relaxing the 60-day consultation obligation, as this does not work well with the idea of furloughing and the flexibility that this aims to bring employers.

Additionally, employers should not be encouraging their employees to opt out of auto enrolment and it is a statutory offence to do so. An employee must pay the minimum auto enrolment contribution of 5% on qualifying earnings unless the employer pays this.

There is no flexibility on this in the auto enrolment legislation. If the employee is furloughed they will be required to pay 5% of their furlough salary as a pension contribution in order to benefit from the 3% employer contribution offered by the JRS.

Pension contributions via salary sacrifice

The guidance says that benefits provided through salary sacrifice schemes (including pension contributions) that reduce an employee’s taxable salary should also not be included in the furlough salary. Therefore, employers should use the lower post-salary sacrifice amount on which to base their claim to HMRC.

Although employees should be able to switch freely out of a salary sacrifice scheme as coronavirus counts as a ‘life event’, they will not gain from this as the amount an employer can recover under the JRS will not change.

This is because the salary used to determine the furlough salary is the salary that was being earned as at 28 February 2020.

Employees are likely to expect their employer to pay the ‘sacrifice contributions’ over in full and may not look kindly if this does not happen. The problem is that employers are not permitted to use the Government grant to pay for benefits under a salary sacrifice scheme.

Where an employer provides benefits to furloughed employees, including through a salary sacrifice scheme, these benefits should be paid in addition to the employees’ wages and the cost of these benefits cannot be claimed under the JRS.

If the employer is under a contractual obligation to provide certain benefits (e.g. pension contributions), and the employer is unable or unwilling to continue to do so in the current climate, the employer should seek the employee’s written agreement to temporarily suspend the provision of such benefits while the employee is furloughed. If this agreement is not forthcoming, the employer will be in breach of contract and thus the employee could take legal proceedings against them.

Bearing in mind the deadline for making pension contribution payments has been extended by the Pensions Regulator, if cash flow is an issue for the employer, the most sensible course is probably to put the matter in abeyance pending a return to work and for a meeting to be set up to plan how the contribution deficit is to be made up.

The other alternative is that an employee accepts that the deficit will not be made up, thereby possibly triggering some claim for compensation in another form.

Defined Benefit Schemes

The Government’s announcements on furloughing do not specifically mention Defined Benefit (DB) schemes, so it is unclear what impact furloughing will have on them. If no change is being made to pay and benefit terms, the impact on DB accrual may be minimal.

On the other hand, if the employees’ pay is being reduced in the furlough period, it may prove necessary to suspend pensionable service during the period and recommence it when the furlough period is over. In this instance, the employer would have to enrol the employees into a DC scheme to which statutory minimum contributions can be paid.

The alternative is for the employer to adjust the benefit accrual to take account of the furlough period, but this is likely to require a lot of professional advice and therefore could be costly to implement.

Employers who are agreeing furlough terms for DB employees will need to be very clear on how any reduction in pay during furlough will affect pensionable pay for benefit purposes, especially if the employer is not otherwise intending to exercise a discretion or augment benefits to protect the employee's accrued benefits from any temporary reduction in pay. It seems unlikely that an employee would readily agree to furlough terms which also prejudiced accrued benefits.

Death-in-service

Death-in-service provision is another concern for both DC and DB scheme members. That cover may be reduced during the furlough period if pay has been reduced.

If an employer wants to maintain life cover benefits by reference to the employee's pre-furlough salary, then changes may need to be made to either the underlying trust documents that govern the relevant arrangement and/or any underlying policies of insurance.

How Tilney can help

This scenario is unprecedented and it has been estimated that up to nine million employees might be furloughed during the course of the pandemic.

The rules surrounding pension contributions are complicated for both employers and employees at the best of times, let alone during a furlough period.

Our team of expert financial planners are at the end of the phone if you have any questions about the impact of furloughing on your pensions.

Please do get in touch. You can call on 020 7189 2400 or book an appointment for a free initial telephone consultation.

This article is based on our understanding of current legislation and is solely for information purposes. It is not intended to be, and should not be construed as advice. Whilst considerable care has been taken to ensure the information contained within this commentary is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.