The Net Pay Anomaly: Call for evidence on pensions tax relief administration

22 July 2020

The Treasury has published a call for evidence to explore the main methods of administering pensions tax relief, and to look into how improvements to processes could be made to address the anomaly that currently exists for some employees.

Background

Employers operate one of two pension scheme types in relation to auto-enrolment. One of those schemes is the Net Pay Arrangement pension (NPA). This involves deducting an employee’s pension contribution from their gross pay, prior to tax deductions - the theory behind this being that it reduces the amount of tax an individual pays.

The other is the relief at source arrangement (RAS). In a scheme of this nature, pension deductions are taken from the employee’s net pay - after tax deductions - which forms 80% of the contribution. The remaining 20% is claimed back by the pension scheme as tax relief from HMRC and added to the individual’s pension pot.

The rationale is that both types of arrangement offer tax relief for employees on their pension contributions but unfortunately this is not the case for every single pension contributor. When an employer chooses a pension provider, the pension scheme they choose may work well for some of its employees but not for others.

The auto-enrolment threshold is for earnings above £10,000 but the current basic tax threshold is £12,500. Anybody who is earning between £10,000 and £12,500 and in a net pay arrangement pension scheme will have a full pension deduction taken from their pay but will not receive any tax benefit on this contribution as they have not earned enough to attract tax on their earnings. If they were in a relief at source arrangement, they would only have 80% of the contribution taken from their net pay which would then be topped up with 20% from HMRC and they would therefore enjoy the benefit of tax relief. It becomes apparent that something as simple as the way in which relief is claimed can have a massive impact on the pension savings of employees up and down the country.

This call for evidence was announced at Budget 2020, and reveals that the government is considering four potential methods in aligning relief at source pensions with net pay arrangement pensions. They are:

• Lower earners who are in NPA schemes will receive a bonus from HMRC, which puts them in the same position as lower earners in RAS schemes. Affected individuals would be identified by using the current end-of-year process, and HMRC would pay them with a payment to equal the basic rate of tax on their contributions
• HMRC could apply a standalone charge to recover the top-up provided to those under the RAS method. The government is opposed to this proposal, however, as it means effectively taking money from those on lower-incomes which they could be saving for their retirement
• Employers could provide two schemes for their employees – one net pay and one relief at source, but this would be on a voluntary basis as it would mean substantial amounts of work from employers, payroll and pension providers
• All Defined Contribution (DC) pension schemes must be operated on a relief at source basis, and not net pay arrangement. The government finds this to be an attractive option as it means one sole method of tax relief for DC savers.

This call for evidence is UK wide and will be of interest to:

• pension scheme administrators operating either the net pay or relief at source method of tax relief
• employers who enrol their employees into a pension
• individuals who receive pensions tax relief at a different rate to their marginal income tax rate
• pension professionals and tax professionals
• payroll administrators

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