Former pensions minister tries to solve pension tax loophole

Former pensions minister tries to solve pension tax loophole

Former pensions minister Baroness Altmann is trying to find a solution to a loophole in which as many as 300,000 low-earners are being denied tax relief.

Baroness Altmann is in preliminary discussions with several software providers to develop a solution that would automatically enrol low-paid workers into a relief at source scheme chosen by the employer.

This solution would need to be automated and done via payroll. She told FTAdviser at least one software provider was open to developing such a proposition.

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Baroness Altmann, who served as pensions minister from 2015 to 2016, decided to work on a solution after inaction from government and regulators.

She told FTAdviser: "All the responses have been 'yes, this is an issue' but everybody passes the buck.

"These workers are denied any choice whatsoever, and simply have money taken away from them, which shouldn't be. These are the people that probably can least afford to pay extra for their pension."

Members of pension schemes who don't pay income tax are nonetheless permitted to basic rate tax relief at 20 per cent on pension contributions up to £2,880 a year.

In practice this means HM Revenue & Customs (HMRC) will top up a net contribution of £2,880 to a gross £3,600.

But this tax relief is only available where the pension scheme operates on a relief-at-source basis, which is only accessible through 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 income tax personal allowance increased to £11,850, which is above the auto-enrolment minimum threshold of £10,000.

HM Treasury has not taken any action on this matter, saying previously it is "up to employers, not government, to decide which scheme best suits the needs of their employees".

This tax loophole was branded the "next payment protection insurance scandal", with only three of the top 17 master trust providers in the UK market offering relief at source to their members.

Other master trusts are aware of this problem, with Smart Pension pledging last year to introduce a relief at source option during this year.

Baroness Altmann hoped to be able to present a solution for employers in the next six months. In the meantime, she would continue to write to government press for a change in legislation.

Alan Chan, director and chartered financial planner at London-based IFS Wealth & Pensions, said Baroness Altmann’s solution could work but he wasn’t fully convinced, since it would mean that all payroll providers would need to adopt it for it to be effective.

He said: "I believe a better solution would be to ban net pay arrangements for auto-enrolment schemes, as this is largely beneficial only for higher rate and additional rate tax-payers by getting the pension contribution deducted gross before tax is applied. 

"By having just relief at source it will even the playing field and so everyone will receive basic rate tax relief automatically, and the higher rate and additional rate payers will need to manually apply for the extra relief."