In July 2022, the Government published draft legislation to correct the so called ‘Net Pay anomaly’ which has resulted in lower earners missing out on pensions tax relief.
As we covered in our February edition of Vision, this longstanding issue arises because of the difference in how pension tax relief works between the Relief at Source (RAS) method and the Net Pay Arrangement (NPA). Under RAS, contributions are deducted net of basic rate tax relief from net pay and members automatically receive a 20% top-up from the Government, even if they pay no income tax. RAS is the method typically used for contract-based pension schemes as well as for NEST and some master trusts.
Through the NPA, pension contributions are taken from gross salary before tax is calculated, meaning employees receive immediate tax relief at their highest marginal rate. For those earning below the income tax threshold however, their marginal rate is 0%. The effect is that low earners in NPA schemes have less take-home pay than they would if they were saving into a scheme that uses RAS. NPA tax relief is typically used for trust-based pension schemes including many master trusts.
Under the proposed changes, which would be effective from 6 April 2024, HMRC will make top-up payments directly to individuals who save into NPA schemes, but whose total taxable income is below their personal allowance. As a result, lower earning pension savers should receive similar outcomes regardless of how their pension scheme is being administered for tax purposes.
HMRC will notify those who are eligible and invite them to provide the necessary details for the top-up to be paid directly into their bank account. HMRC will make the payments as soon as is reasonably practicable following the tax year in which the contribution was paid. This should have minimal impact on pension schemes as HMRC will contact individuals directly.
According to government figures, this will benefit approximately 1.2 million individuals, 75% of whom are women, who could benefit by an average of £53 a year.