HM Treasury is standing by an apparently arbitrary rule that sees some low income earners receive a 25 per cent bonus on pension contributions and others receive nothing.
HM Treasury's position is despite the fact the impact of the anomalous rule is set to increase significantly when auto-enrolment contribution rates rise and more low-income earners are potentially included in the auto-enrolment regime.
HM Treasury repeatedly refused to clarify whether or not it was government policy to provide a 25 per cent government bonus to non-taxpayers' pension contributions, justifying its position simply on the grounds that it was "technically and legally correct".
The rule in question relates to two distinct methods with which workplace pension schemes approach tax relief: "net pay" and "relief at source".
Pension schemes that use the "relief at source" model receive pension contributions from after-tax pay, and apply directly to the government for tax relief. The government provides this tax relief at a flat 20 per cent rate.
Schemes using "net pay", meanwhile, take pension contributions from before-tax pay, and therefore make no application for tax relief to the government.
The result is that members of "relief at source" schemes who earn below the £11,500 tax-free threshold receive "tax relief" from the government, while those who are members of net pay schemes receive nothing.
Tax relief of 20 per cent for someone who does not pay tax amounts to a 25 per cent bonus, because the employer only contributes 80 per cent of the member's contribution.
The difference, therefore, applies to take-home pay rather than pension contributions.
According to Graham Peacock, managing director of auto-enrolment provider Salvus Master Trust, the net pay system is a more efficient way of collecting pension contributions.
He said it was unfair that members of schemes which, like his, use this more efficient method should be denied the 25 per cent bonus.
He said that, in its auto-enrolment review, the government had already flagged the possibility of dropping the £10,000 a year earnings trigger that makes people eligible for auto-enrolment contributions, as well as the lower band earnings threshold of £5,876.
If this went ahead, Mr Peacock said it would significantly increase the number of people affected by the net pay/relief at source anomally.
"We are sleepwalking towards one of the most unfair policies, where depending on the type of scheme your employer chooses for you, you either get a government bonus or you don’t. And that is just wrong," he said.
Former pensions minister Ros Altmann agreed, saying she had repeatedly tried and failed to get the Department for Work & Pensions, HM Treasury and The Pensions Regulator to take the issue seriously.
"I am afraid the government – both DWP and Treasury – were simply not interested in the plight of low earners who are losing out on the 25 per cent bonus they could and should have," Baroness Altmann told FTAdviser.
"The worker has no control over the pension scheme chosen by their employer and is often led to believe that they will get tax relief. In relief at source schemes they would indeed have it, but the Treasury denies any mechanism to give them the bonus in a net pay scheme.