Samantha Mann examines the current application of pensions tax relief and asks whether the rollout of auto enrolment is helping the very people targeted by the policy – the low paid.
The rollout of workplace pensions savings in the form of automatic enrolment has been deemed to be a success by the Department for Work & Pensions (DWP). The headline figures from the Pensions Regulator (TPR) announce that 1.3m employers have confirmed that they have met their duties and 9.9m employees are now able to save more as a result of auto enrolment.
A government policy success maybe, but there are growing questions about the fairness the government is providing to the very people this policy aims to help most – the low paid.
Net pay arrangements vs relief at source
Prior to the 2018 Autumn Budget, calls were made by the Low Income Tax Reform Group (LITRG) for the Chancellor to turn his attention to the issue of inequity as it relates to the application of tax relief under net pay arrangements.
Net pay arrangement (NPA)
Net pay arrangements have been in use for many years by public sector pensions schemes and more recently by an increasing number of workplace pension schemes used to administer auto enrolment.
The advantage of NPA is that the employee (or scheme member) need do nothing to access the tax relief due to them as the pension contributions are deducted from salary before income tax is calculated, leaving the pension scheme to automatically claim back tax relief at the highest rate of income tax.
As a result of recent increases to the personal allowance and the increased numbers who have been automatically enrolled into pension saving, the unfairness continues to grow.
In its recent Budget submission LITRG confirmed that 1.22m individuals in net pay arrangements had been unable to access tax relief in the 2015-16 tax year.
You may be thinking ‘why is this unfair’? If you don’t pay tax should you should be able to claim tax relief?
Pension tax relief for non-taxpayers and low earners
Government policy continues to encourage pension saving using ‘tax relief’ as an incentive, and currently policy allows non-taxpayers to benefit from tax relief of 20% (current basic rate of tax), even though they don’t pay tax.
Members of pension schemes who don't pay income tax are permitted to receive basic rate tax relief on pension contributions up to a maximum of £2,880 a year which results in an increase in value of the contribution to £3,600. However, this tax relief is only available where the employer operates a pension scheme on a relief at source (RAS) basis and is not available for schemes that operate a net pay arrangement.
Relief at source (RAS)
Relief at source applies to all personal pensions as well as to many workplace pensions.
The pension contributions in a RAS scheme does not affect the calculation of taxable pay as the contributions are deducted net of tax at the basic rate (currently 20%). The scheme administrators will later claim the basic rate tax relief back from HMRC.
The disadvantage of a RAS scheme process for scheme members who are higher rate tax payers is they will need to complete a self assessment tax return to receive the extra relief due to them.
However, all individuals in a RAS scheme will benefit from tax relief at the basic rate whether they are a taxpayer or not.
Hence the increasing calls for change.
Devolution impact on rates and thresholds
The highest rate of income tax is applied to pension contributions of the employee, which due to the varied bandwidths and rates is different now for Scotland to those whose main residence is in the rest of the UK:
Rest of UK
- Basic-rate taxpayers get 20% pension tax relief
- Higher-rate taxpayers can claim 40% pension tax relief
- Additional-rate taxpayers can claim 45% pension tax relief.
- Starter rate taxpayers pay 19% income tax but get 20% pension tax relief
- Basic rate taxpayers pay 20% income tax and get 20% pension tax relief
- Intermediate rate taxpayers pay 21% income tax and can claim 21% pension tax relief
- Higher-rate taxpayers pay 41% income tax and can claim 41% pension tax relief
- Top rate taxpayers pay 46% income tax and can claim 46% pension tax relief.
In a pension salary sacrifice there will be no employee contribution as the employee has given up (sacrificed) their salary in exchange for an enhanced employer pension contribution.
Giving up the salary is the method applied that reduces pay for income tax purposes (and also allows a reduction in Class 1 national insurance contributions for both the employer and employee), where the employee earns enough to pay either.
The data that is sent to the pension provider should not record any employee contributions. If it does, the provider may improperly claim tax relief as if it is a RAS scheme.
Pensions tax relief: the bigger picture
The gross cost to the government of pensions tax relief in 2016-17 was projected to be £38.6bn, and whilst calls continue to grow for reform to the current policy, government response so far continues to be in the negative – due, it is said, to the “lack of consensus” as to a way forward.
Auto enrolment as a policy was widely promoted as being a partnership between the employee, the employer and the government in that each would contribute to the pension savings for the scheme member. However, as the earnings trigger for auto enrolment remains a static £10,000 and the personal allowance grows to £12,500 from April 2019, which the Chancellor proudly announced as being delivered a year earlier than predicted, it would seem that the unfairness is set to grow.
The current impact on the non-tax payer is aptly demonstrated by the LITRG, which sent an open letter to the Chancellor in advance of his Budget in October and drew widespread attention to the fact that an individual within an NPA scheme currently earning £11,850 and paying the minimum contributions required under auto enrolment is missing out on £34.91 in the current tax year as compared to someone in a RAS scheme.
About Samantha Mann
CIPP senior policy and research officer