Small businesses are shouldering a new pensions burden

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Don’t be tempted to try to trim your pension commitments

Small firms must soon pay more into their workers’ pension funds.

Barely two months after the last small businesses moved into the auto-enrolment pensions regime, the clock is now counting down fast to a big increase in the cost of the scheme. From 6 April, the first day of the 2018-2019 tax year, the minimum contribution employers must make to the pension pots of their employees will double from 1% of pensionable pay to 2%.

Auto-enrolment, which requires all employers to offer a pension scheme to staff and automatically to enrol everyone except those who specifically opt out, is widely considered to be a success, with nine million people now in a workplace pension they didn’t have before the scheme began in 2012. But while auto-enrolment was phased in gradually, with low minimum contribution rates for employers and employees alike (and with the smallest employers only having to comply from
1 February this year), the scheme is now set to ramp up.

From next month the total minimum contribution from employer and employee under auto-enrolment increases to 5%, with employees expected to pay three percentage points of this. In April 2019, this minimum is due to increase again, to 8%, with the employer and employee contributions rising to 3% and 5% respectively. The new rules won’t affect employers already paying above the new minimums – as many do – but there will be significant numbers facing substantially higher staff-pension costs. Auto-enrolment contribution rates only apply on employees’ qualifying earnings (pay between £5,876 and £45,000 in the 2017-2018 tax year) but the higher minimums will nevertheless hit some employers hard.

The smallest businesses, which may only just have got used to paying pension contributions, may find the higher costs particularly hard to deal with. One possibility is to seek to reduce costs elsewhere. Research published by the Department for Work and Pensions (DWP) suggested some employers plan to deal with the higher bill for pensions by offering less generous salary increases, keeping their overall pay and benefits costs down. But many firms told the DWP that they would simply absorb the costs.

Employers also need to consider whether to write to employees to inform them of the forthcoming changes. While there is no statutory obligation to do so, financial advisers suggest this is good practice. The Pensions Regulator publishes a template on its website for employers offering such guidance. It may be that some employees decide that they wish to opt out of the pension scheme rather than pay higher contributions themselves, particularly when their minimum payment rises again in April 2019. However, while it might be tempting for employers worried about costs actively to encourage staff to opt out, this is illegal. The Pensions Regulator has powers to levy substantial penalties on employers judged to be trying to persuade staff to opt out.

Tax changes may squeeze directors

With just weeks to go until the end of the 2017-2018 tax year, directors of small businesses are running out of time to use their £5,000 tax-free dividend allowance. Unused allowance can’t be carried over to the new tax year, beginning 6 April, and the value of the allowance will more than halve from 2018-2019 onwards. The rules affect those who choose to pay themselves through dividends rather than a salary. This has been popular with small-business owners; changes to the rules introduced two years ago have reduced its attractions, but many entrepreneurs continue to operate this way.

Under the current rules all taxpayers are entitled to receive dividend income of up to £5,000 before they pay any tax at all – this is total dividend income including any from investments. Above this level, basic-rate taxpayers pay 7.5% tax on their dividends, higher-rate taxpayers pay 32.5% and additional-rate payers 38.1%.

From next month the £5,000 allowance will fall to £2,000. People earning most of their dividends from investments may be able to use Isas to shield their gains from tax. For small-business owners, however, this won’t be an option. It may be possible to plan your affairs to mitigate your tax liability – perhaps where a spouse is a fellow director, for example – but take professional advice on how to remain on the right side of the rules.