The number of low earners that won’t be able to get tax relief for their pension is set to increase next year, after yesterday’s (22 November) announcement of an increase in the personal allowance.
Chancellor Phillip Hammond revealed the individual allowance would increase from £11,500 to £11,850 from April, in line with inflation.
According to Jon Greer, head of retirement policy at Old Mutual Wealth, this means that “more workplace pension savers may fall into a tax hole” if they are auto-enrolled into a scheme that operates tax relief through the net pay arrangement system.
Members of pension schemes who don't pay income tax are nonetheless permitted to basic rate tax relief (20 per cent) on pension contributions up to £2,880 a year.
In practice, this means that HM Revenue & Customs (HMRC) will top up a net contribution of £2,880 to a gross £3,600.
However, this tax relief is only available where the pension scheme operates on a relief-at-source basis, which is only accessible through less than a hand full of companies.
It is not available for schemes that operate a net pay arrangement, which are the majority of pension funds in the market.
The difference between these two arrangements has become more noticeable since the nil rate income tax band has increased – currently at £11,500 – which is above the auto-enrolment minimum threshold of £10,000.
According to Sir Steve Webb, director of policy at Royal London and former pensions minister, the extra numbers affected from an increase in the allowance to £11,850 “is probably relatively modest - probably a few tens of thousands - but the fundamental problem still remains”.
The Department for Work & Pensions (DWP) has estimated that around 280,000 people who earn between £10,000 and £11,500 wouldn’t benefit from tax relief on their contributions if enrolled in a pension scheme that uses a net pay arrangement.
He said that “the Treasury now needs to find a solution rather than keep making the problem worse”.
According to Mr Greer, “some schemes have stepped-in and are funding the difference themselves, ensuring their members falling through the gap are receiving the equivalent of basic-rate tax relief”.
This is the case of Now: Pensions, which has been in talks with the HMRC to find a solution for this issue on the long-term.
Mr Greer arguer, however, that “there seems to be little ownership of this problem”.
In a written response to Baroness Ros Altmann about this subject, Lord Bates said that “the government recognises the different impacts on workers earning below the personal allowance”.
He said: “However, it hasn’t been possible to identify any straightforward or proportionate means to align the effects of the net pay and relief at source mechanisms more closely for this population.”
The Treasury has previously said that it is up to employers to choose what option is best for the needs of their staff.
Nevertheless, there is hope that this situation might change with the current auto-enrolment review, which will be presented next month, since the minimum threshold might be changed.
According to William Burrows, retirement director at Better Retirement, “just because some people have small pension pots they shouldn’t be treated as second class citizens, and they should enjoy the tax relief as everybody else”.
He said: “I am sure most of the schemes for lower paid employees offer good value but they would be even better if all members benefited from the tax relief bonus."
maria.espadinha@ft.com
