One of my colleagues, David Palmer, thought further after my musings on perverse pension contribution incentives and wrote a note about the treatment of pension contributions in Universal Credit for the news update service of ucForward, our new benefits advice system that includes probable future benefit entitlements. Well worth reproducing here.

“One of the unexpected announcements in the UC draft regulations as published recently was the fact that 100% of pension contributions are to be disregarded for the purpose of calculating net earnings.

This revelation had not been trailed at all, and previous statements had indicated a 50% disregard, in line with that applied currently in the means-tested benefits.

The suspicion has arisen in some quarters that this unexpected generosity (see below) on the part of the UK Government has more to do with logistical matters – in particular constraints of the ‘Interim solution’ to the problem of feeding PAYE data from HMRC to DWP – than any compassionate turn in policy circles.

Currently, if a claimant increases their pension contributions by (say) £100 a week, then 41% of that amount is in effect rebated by increased Tax Credits i.e. £41 a week

If they also receive Housing Benefit, then net earnings for HB purposes reduces by £50 but this is offset by the extra £41 of tax credit income, giving a net lift of £5.85 a week. So the total rebate in effect is £46.85 in this situation.

With Universal Credit, given the 100% disregard, the total rebate is £65 a week just because the taper in UC is much higher than that of the Tax Credits. (Previously it would have been £32.50 with a 50% disregard, a figure that is closer to that applying at the moment.)

The better-off you are, the more likely you are able to make pension contributions, and still thrive on the remainder. A single parent with two children, working for 35 hours with gross earnings of £900, with childcare costs of £160 and rent of £85 (all amounts weekly) will retain UC payable of about £6 a week on current best estimates. She will also be a higher-rate taxpayer, and may well decide to commit £100 a week in pension contributions. If she does so, her UC will increase to about £71 a week.

It’s hard to see why anyone in this situation would not take advantage of what is in effect a 65% subsidy of their pension pot from the public purse. The beleaguered pension industry must surely be rubbing their hands in glee at the prospect (or will be, when they wake up to the consequences).”

This doesn’t take into account the additional longer term tax advantages of pension contributions which further add to the attractiveness of the situation, for those who can afford the smaller drop in actual disposable income that increasing contributions brings.