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 – has been hitting the headlines.
The controversy has arisen because of a wrinkle in the system for employees who earn less than £10,600 a year and don’t pay income tax.
Until April 2015, both the nil rate tax band and the auto enrolment earnings threshold were £10,000 per year. That meant that employees eligible for auto enrolment were also taxpayers, and therefore received income tax relief regardless of which method of contribution their pension administrator adopted.
From April 2015, the auto enrolment earnings threshold remained at £10,000, but the nil rate tax band was increased to £10,600. This separation has created a tax anomaly in that members with salaries between the two figures are disadvantaged under net pay arrangements.
Under net pay, these savers pay no tax and so get no relief. But under relief at source, HMRC automatically send them the 20% back even though they are non-taxpayers.
NOW: Pensions want to ensure that all savers receive the income tax relief they are entitled to and we are working with the Treasury and HMRC on a long term solution to this issue. In the interim however, we have announced that we will make up the tax relief shortfall for scheme members that aren’t taxpayers in respect of the 2015/16 tax year.
What’s the difference between 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 relief at source and is usually offered by Group Personal Pension 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 relief at source 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.
With net pay, 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!
We believe that net pay offers a number of benefits to savers and if we can agree a long term solution to this issue with HMRC we’d be keen to do this in order to avoid the upheaval and expense of moving to relief at source.
How will the top up work?
- Information about the top up will be included within members’ 2015/16 benefit statements
- Members who do not pay income tax on their earnings will be directed to a short claim form on the NOW: Pensions website and a letter of authority, permitting HMRC to divulge tax details to NOW: Pensions
- The completed claim form and letter of authority would need to be submitted to NOW: Pensions by the end of October 2016
- NOW: Pensions would then liaise with HMRC to confirm that these members do not pay tax
- Once confirmed, NOW: Pensions will credit members’ pension pots with the tax relief they would have received in a relief at source arrangement
- This amount will be credited by the end of March 2017 to coincide with the scheme year as well as the tax year
Further information will be available on the website later this year and we will keep you updated on this.