REWARD
Taxation of pensions
Helen HargreavesMSc ChFCIPPdip, CIPP associate director of policy , provides a comprehensive explanation
W e all know that when the government wants the public to do something, it will often use tax breaks to encourage us to comply, with perhaps the most widespread being the pension tax relief that is afforded to those using a pension to save for retirement. But is it really so straight forward, and do we all really benefit? Workplace pensions The government tells us that when we make a contribution to our pension, it will add money too in the form of tax relief and is one of the main advantages of using a pension to save for retirement. But whilst this is true, it doesn’t tell the whole story, as there are different ways of attracting pensions tax relief, and it may be that not everyone gets the tax relief they might have expected. Employers operate one of two pension scheme types in relation to auto- enrolment. One of those schemes is the net pay arrangement (NPA) for pension contributions. This involves deducting an employee’s pension contribution from their gross pay, prior to tax deductions – the theory behind this being that it reduces the amount of tax an individual pays. The other is the relief at source (RAS) arrangement. In a scheme of this nature, pension deductions are taken from the employee’s net pay – after tax deductions – which forms 80% of the contribution. The remaining 20% is claimed back by the pension scheme as tax relief from HM Revenue and Customs (HMRC) and
added to the individual’s pension pot. The rationale is that both types of arrangement offer tax relief for employees on their pension contributions but unfortunately this is not the case for every single pension contributor. When an employer chooses a pension provider, the pension scheme they choose may work well for some of its employees but not for others. The auto-enrolment threshold is for earnings above £10,000 but the current basic tax threshold is £12,500. Anybody who is earning between £10,000 and £12,500 and in a NPA pension scheme will have a full pension deduction taken from their pay but will not receive any tax benefit on this contribution as they have not earned enough to attract tax on their earnings. If they were in a RAS arrangement, they would only have 80% of the contribution taken from their net pay which would then be topped up with 20% from HMRC and they would therefore enjoy the benefit of tax relief. It becomes apparent that something as simple as the way in which relief is claimed/obtained can have a massive impact on the pension savings of employees up and down the country. Employees who do not earn £10,000 or above to meet the threshold for auto-enrolment but ask to be added into a pension will also be affected. This is also true for individuals who don’t reach the threshold, but in some pay periods experience a pay spike, e.g. they receive a bonus. If this pay spike pushes them
into the £10,000 earnings bracket for that pay period and there are further spikes in subsequent pay periods, then contributions will be taken in line with auto-enrolment legislation but, again, there will be no tax benefit to the employee if they have not have earned enough for tax deductions to be taken. Conversely, in a RAS arrangement, employees who are earning within the higher and additional tax brackets only receive a 20% top up to their pension pots from HMRC through payroll, as opposed to the 40% and 45% they are entitled to (21%, 41% or 46% in Scotland). In order to receive the extra relief due to them, these individuals need to complete a self-assessment tax return. Many of those affected by this may not be aware of the processes they need to follow to receive the relief or may not be aware of the additional entitlement at all. Although, in an unusual twist, Scottish taxpayers on the starter rate of 19% also receive the 20% top up. Net Pay Action Group There are an estimated 1.3 million workers (75% of whom are female) earning below or just above the personal income tax allowance not receiving tax relief on some or all their contributions because their employer’s pension scheme uses NPA; this makes pension saving up to 25% more expensive for them as compared to a worker contributing to a RAS arrangement. The CIPP is a member of a group campaigning to ensure that there is a level playing field for all pension contributors, and strongly believes that the government should address these issues. We will keep you updated as the campaign progresses.
...the way in which relief is claimed/ obtained can have a massive impact...
| Professional in Payroll, Pensions and Reward | April 2020 | Issue 59 32
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