There has been a lot of comment in the media recently about the fact that there are two different ways that pension schemes can collect the tax relief that savers enjoy when contributing to a pension – net pay and relief at source.
Traditionally, occupational and trust based schemes have operated a net pay arrangement where employers collect pension contributions off the top line of payroll, and then just pass the remaining pay, after pension contributions have been deducted, through PAYE to take off income tax for each employee. Because the pension contribution is taken before income tax has been deducted, tax relief is automatic and no tax is paid on the money being contributed to a pension.
The alternative system is called “pensions tax relief at source” (PTRAS) and is usually offered by GPP schemes. Here, employers take an individual’s pension contribution off the bottom of the payslip, so from pay after income tax has been deducted. The tax relief is then reclaimed from HMRC by the pension scheme, who send in a monthly request and get the cash back about six weeks later. HMRC are pretty prompt at dealing with these, but they only send back the basic rate of tax, namely 20%.
Where an employee in a scheme operating PTRAS is a higher or additional rate taxpayer they can claim back the rest of the tax relief themselves from HMRC, and there is a box on their annual self-assessment tax return for this purpose.
You might be forgiven for thinking that the “net pay” method is obviously better. The tax relief is automatic, and it arrives and can be invested immediately, without the six week delay for basic rate taxpayers and a wait until the end of the year for higher rate taxpayers. The latter of course don’t get their relief if they forget to ask for it at the end of the year, which is possible as we can all be forgetful and quite likely if nobody ever told them about this box on the tax return!
But, there is a nasty wrinkle in the system for employees who earn less than £10,600 a year and so don’t pay tax. Under net pay, they pay no tax and so get no relief. But under PTRAS, HMRC automatically send them the 20% back even though they are non-taxpayers.
The position in the 2015/16 tax year predominantly only affects those earning between £10,000 and £10,600, and the additional tax home pay is minimal – between £0.70 per month (for those earning £10,000 pa) and £0.80 per month (for those earning £10,600 pa).
NOW: Pensions offers employees who earn less than £18,000 a reduced administration charge (they pay 30 pence per month as opposed to £1.50 per month). At the moment, this more than offsets the tax relief that these members might be missing out on (80 pence per month). However, this disparity will only increase if nothing is done to correct the inequality given that the nil rate tax band will rise to £12,500 during the current Parliament.
One solution to this problem would be for net pay schemes to move to relief at source but with the outcome from the Chancellor’s tax relief consultation yet to be announced, making such a big decision without clarity on the future of tax relief is impossible.
If the existing system of pensions tax relief remains unchanged, we’ve come up with an end of year “sweep up” idea for net pay scheme which would resolve this problem but would involve some extra work for both pension schemes and HMRC. We think this is better than moving to relief at source, which delays everybody’s tax relief for the sake of just a few individuals in a thin band of earnings.
At the end of the tax year, the pension scheme would submit a declaration to HMRC of employee contributions received under the net pay method, showing one line per member, identified by national insurance number and showing their total employee pension contribution during the year.
HMRC match the pension data against P60 data, and identify employees who missed out on pension tax relief because they paid pension contributions under a net pay arrangement but received no benefit as their total taxable earnings for the year was below the income tax personal allowance.
HMRC calculate the missing relief, which will be 25% of the pension contribution, but subject to a ceiling as if the total of taxable earnings for the year and pension contributions made is greater than £10,600 then relief will have already have been granted under net pay for the top slice of pension contribution that took the total above the personal allowance.
HMRC send one payment to the pension scheme with a record breaking it down to the amount for each employee against their national insurance number.
The pension scheme applies the payments to the accounts of each affected individual, purchasing additional units at the date of receipt of the payment from HMRC. The payment is shown on the employee’s pension plan as “tax relief for employee earning below income tax personal allowance.”
Crucially, the solution places no burden on the employer and doesn’t require any action by the employee.
We have been clear that once the future of pensions tax relief is clarified, NOW: Pensions will amend its operational structure appropriately if that’s the best way for savers to receive the tax relief they are entitled to. However, we do believe that net pay offers a number of benefits to savers and if we can agree a work around with HMRC we would be keen to explore this to avoid unnecessary upheaval for our clients.
Meanwhile, the charge reduction that NOW: Pensions offers to low paid employees is 50% more valuable than the extra tax relief they might get under PTRAS, so employers needn’t be influenced by the lop-sided messages emanating from the Pensions Minister and The Pensions Regulator.
Adrian Boulding is Director of Policy at NOW: Pensions