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Is the current system of pensions tax relief fair?

20th Nov 2018
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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.

Salary sacrifice

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.

Replies (12)

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By David Heaton
20th Nov 2018 12:44

What are those who call for reform suggesting? Fairness at the top end is dealt with by the annual and lifetime allowances, which limit tax relief for high earners. Surely the problem, if there is one, at the bottom end is the net pay approach? Are those calling for reform suggesting that low earners ought to be given an extra tax allowance (how would that help if they are non-taxpayers?) or have a credit paid to their pension by HMRC? How complex would such a system have to be to level the playing field accurately and fairly?

Firstly, how likely is it that a person paying only £175 per year into a private pension (to get £35 of tax relief) will be troubling the taxman when they draw the resulting pension in due course? Not very, given that the personal allowance is already £3k higher than the flat-rate state pension.

Secondly, if those affected were in group personal pensions, they would get tax relief automatically added to their pension pot, even though they hadn't paid any tax. Employers can deal with that by opting for RAS arrangements instead of net pay. And as low earners, they probably still won't have any tax to pay when they finally draw their pensions.

I know £35 is a lot of money when you have none (I was a student once upon a time, so I do know what it's like!), but those affected don't actually get that free money for years, and I wonder whether the Chancellor doesn't have bigger fish to fry.

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By ireallyshouldknowthisbut
20th Nov 2018 13:48

Funny, I thought this article would be going the other way.

I have noted lots of payments coming out of net pay after income tax is deducted, not out of gross pay, so higher rate tax payers don't get the proper deductions for relief due.

I don't follow the logic that a non-tax payer ought to be getting basic rate tax relief on pensions. Quite frankly they probably ought not be paying into a pension in the first place, but putting the funds into an ISA.

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By User deleted
20th Nov 2018 15:28

Mandate that all ee contributions are made (for tax) as though a Salary Sacrifice arrangement is in place - ie give full IT and NIC relief at source

Then consistent, simple, full relief is given (incl for NIC) and no one is disadvantaged because their company doesn't jump through the Sal Sac hoops and advisers don't need to look at each person's payslips to see what to do in their SA return re pension contributions.

Easy really. My appointment to the highest levels of government awaits

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Replying to User deleted:
By David Heaton
21st Nov 2018 10:39

It sounds easy, doesn't it? But how do you deal with people who pay their own pension contributions, if you want fairness and parity of treatment? One of the simplifications in 2006 was to put everyone paying into a RAP or PPP onto the same footing - basic rate relief at source, with HR relief through SA or a coding adjustment, and a £3,600 (£300 per month) de minimis threshold for worrying about whether relief is due at all. To give employee contributions tax and NIC relief out of gross pay, you need an employer scheme. About 4.5m self-employed people don't have one. So, do you then go back to net pay for all employees and RAS for the self-employed? And FSAVC contributors? Pensions re-complification (not that 'simplification' did anything of the sort, of course ...)?

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Adrian Lawrence
By AdrianLawrence
20th Nov 2018 15:47

The £10K earnings threshold is planned to be abolished in the mid 2020's so whilst no immediate plan at least contributions will increase in due course.

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By Kate Upcraft
21st Nov 2018 13:25

Hi Adrian can you point me to where it’s been announced that the £10k earnings trigger is being abolished? I thought it was the qualifying earnings threshold that was going so that contributions, once triggered begin from pound one rather than the threshold.
The headline in the Times made me smile today saying that Tory policy is now to target support to low paid women. If that’s true, the NPA anomaly ought to be on the agenda as this predominantly affects women and many in the public sector

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Replying to bassett1:
By neiltonks
21st Nov 2018 14:34

The plan is certainly to remove the LEL, not the trigger. However this would itself cause issues because employees earning close to the trigger value, who currently contribute very little, would see a proportionately large increase in contributions. For example from next year someone earning £10,500 will pay £218 in contributions on pay in excess of the LEL. If contributions were on all their pay this would rise to £525. Employers would also see an increase, albeit a smaller one since their contribution rate is lower.

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Replying to neiltonks:
paddle steamer
21st Nov 2018 17:27

Hence why the implementation was misguided, the very people, those say with multiple employments- cleaning job in morning working in after school club in afternoon- were the ones that needed AE the most, a lot of them have now missed out multiple years.

What they ought to have done is started it at a low percentage on all earnings and then wound it up at a slower rate.

I took out a whole of life policy many years ago with a 10% contribution escalator for the first 10 years built in at outset, I never even noticed the increases.

If they had started on all earnings at outset they could have spread the percentage escalation over a longer period, the way this is going to come in is likely going to result in opt outs.

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By johnjenkins
21st Nov 2018 13:26

Can you call a success something that is mandatory to go in yet not mandatory to pay in?

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By dmmarler
21st Nov 2018 13:30

Most low paid earners that I know of opt out of auto-enrolment - they have no spare cash for the luxury. Bearing in mind that if they have rubbish pay, then they get rubbish pension anyway.

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By psimonparsons
22nd Nov 2018 18:15

The NPA tax relief process costs the government nothing. It allows a true relief against an equivalent amount of tax that would have been otherwise paid.

RAS is a guesstimate basis, the investment in the pension is limited to basic rate alone on a delayed claim basis.

It is a pain to administer and potentially complicated as a result of devolved tax.

If government really wants to give away money for those who do not pay tax, then a new means of pension contribution credit needs to be introduced.

The problem is not the NPA.

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By Robbo
23rd Nov 2018 13:50

The fact is that the desire of HMG to force & encourage the low paid to save through pensions is a con trick. People who are barely managing cannot afford to make contributions so why make them? Because it will save HMG money when they retire, any pension income will be taken into account when calculating pension credit or whatever it will be called so it really only HMG that benefits (& the pension company)

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