Tax relief on employee contributions is granted by HM Revenue and Customs (HMRC) in part by way of an incentive for saving into a pension plan, with the employer’s contribution not being assessed for tax on the employee. As such, they are an extremely attractive way for employees to save for their retirement as part of their overall planning.
However, an anomaly between the two methods of tax relief that pension schemes can operate – the relief at source (RAS) basis and the net pay arrangement (NPA) - has resulted in low earners missing out on tax relief under the latter.
Under this method, typically used by trust-based schemes, the employer deducts gross contributions from an employee’s gross pay before calculating income tax using Pay As You Earn (PAYE). In this way the employee should get tax relief immediately at their highest marginal rate. However, if an employee doesn’t earn enough to pay income tax, they won’t get any tax relief. When submitted to the scheme provider, there is no tax relief claimed from HMRC.
Through RAS, which is the method used by contract-based arrangements such as personal pensions, an individual’s contributions are paid net of basic rate tax. The pension provider sends a claim to HMRC for the basic rate tax relief due and applies it to the member’s pension plan. This happens whether the member earns enough to pay income tax or not. Anyone paying tax at higher than basic rate can claim further tax relief due directly from HMRC.
Having pledged in its 2019 election manifesto to fix this issue and following a ‘call for evidence’ in 2020, the Government finally published the outcome of this consultation in October 2021. This confirms that the Government will introduce a system to make top-up payments directly to low-earning individuals saving in NPA schemes in respect of pension contributions made from the 2024/25 tax year onwards.
The Government has stated this change will mean that all lower-earning pension savers should receive similar outcomes, regardless of how their pension scheme is being administered for tax purposes. According to the consultation response, up to 1.2m individuals, broadly 75% of whom are women, could benefit by an average of £53 a year.
To be able to administer the new system, the Government has announced a £71m investment in the modernisation of pensions tax relief administration, including RAS claims.
Importantly, the top-ups will be paid after the end of the relevant tax year, with the first payments being made in 2025/26 and continuing thereafter. The Treasury has said that the time lag between the announcement and implementation of this system is due to the complex nature of the changes required to IT systems. It also believes this basis is preferable, as the whole of a member’s taxable income for the 2024/25 tax year will be known and so the top up can be calculated accurately.
The Government’s response also suggests that HMRC will notify individuals that they are eligible for a top-up, and they will be invited to provide the necessary details for HMRC to be able to make the payment to them. In effect, the onus will be on those disadvantaged individuals to claim the top up by providing payment details, which could mean there is a real risk of non-take up.
To find out more about how this might impact your pension scheme and employees, contact your usual PS Aspire consultant.