The problem of lower paid workers missing out on tax relief has been highlighted as the Department of Work and Pensions has announced that the amount that people need to be earning and at which point they are automatically enrolled into their workplace pension scheme remains at the current threshold of £10,000.
All employers must automatically enrol their staff aged between of 22 and state pension age into a pension scheme and make contributions to their pension (provided they earn a minimum of £10,000). The problem is that the tax allowance tax threshold, below which an individual would not pay tax, is £11,850 and due to rise to £12,500 for 2019/20. So, there is a question-mark as to whether individuals earning between the threshold and the income allowance will get tax relief on their pension contributions.
Employer schemes can operate under a ‘relief at source’ arrangement or a ‘net pay’ arrangement.
If an employer runs a scheme which operates on a ‘relief at source’ system it will deliver tax relief to non-taxpayers. But an employer which operates a ‘net pay arrangement’ (NPA) system for its scheme may not.
Steve Webb, director of policy at Royal London explains: “When an employer chooses a workplace pension, there are various things they may want to think about, but whether all workers get tax relief or not should be one of them – the Pensions Regulator encourages employers to bear this mind when choosing a scheme.
“In principle, an employer with a number of lower paid workers – especially in the bracket above the automatic enrolment floor of £10,000 and below the tax threshold of £12,500 (from next year) should be aware of this; these workers either need a scheme that does ‘Relief at Source’ or a scheme that has put in place measures to correct the problem,” says Webb.
For example, he says one large MasterTrust makes payments to members to compensate for the absence of tax relief. A Master Trust is a particular type of pension arrangement, which must provide money purchase benefits, be used by one or more employers, is not used only be employers connected with each other and in not a public service pension scheme.
How does pension tax relief at source work?
With relief at source a member making a contribution to their pension scheme gets tax relief at the relevant basic rate and the amount paid to the scheme is treated as having had an amount equivalent to basic rate tax deducted. The scheme administrator then claims the basic rate tax relief from HMRC and adds it to the pension pot and this is the same whether or not the member pays tax.
So, the employee (if paying the basic rate of tax of 20%) pays £100 into their pension they’ll only need to pay £80 into the scheme. The scheme administrator reclaims £20 from HMRC and puts this into the scheme making up the pension contribution to £100.
When it comes to higher paid workers one could argue that they would prefer the ‘net pay arrangement’ because this means they get higher rate relief at once rather than having to claim it back through their pay packet; says Webb.
How does a pension net pay arrangement work?
Under an NPA the employer takes the member’s contribution from their pay before it’s taxed so tax is only paid on what’s left. This means the employee gets full tax relief, no matter if they are basic rate or higher rate taxpayers.
However, Webb adds: “But if the scheme runs on a ‘salary sacrifice basis’ then workers get higher rate relief immediately regardless of how the pension scheme delivers tax relief. In general, I guess better off workers are more likely to understand the issues and claim the top-up, which they are able to do, whereas lower paid workers have no means of claiming tax relief in a NPA scheme that doesn’t operate salary sacrifice.”
Webb warns: “The gap between the point at which people are enrolled into a pension and the point at which they start paying tax will become a chasm in 2019. This means hundreds of thousands more workers will find that whether or not they get tax relief will depend on the lottery of what pension arrangement their employer has chosen for them. Government cannot keep kicking the can down the road on this issue. It now needs to be resolved as a matter of urgency”.
In its recent review of the automatic enrolment earning level the DWP said of the earnings threshold that: ‘If it is too high then low to moderate earners who can afford to save (and who are the main target group of the policy), may miss out on the benefits of a workplace pension. Set it too low and the predominant impact will be upon people for whom it could make little economic sense to divert income away from their day to day needs, and this could potentially result in greater numbers of individuals making a conscious decision to opt-out.’
It added that: ‘The existing threshold of £10,000 remains the correct level at this point in the establishment of automatic enrolment and will not change for 2019/20. This represents a real-terms decrease in the value of the trigger when combined with assumed wage growth and will bring in an additional 40,000 individuals into the target population. The decision reflects the key balance that needs to be struck between affordability for employers and individuals and the policy objective of giving those who are most able to save the opportunity to accrue a meaningful level of savings with which to enter their retirement.’