The government is freezing the minimum threshold for auto-enrolment at £10,000 for 2019/20, which means thousands more workers are set to face a ‘lottery’ about whether or not they qualify for pension tax relief, experts have warned.
At present, the threshold for automatic enrolment is £10,000 and the personal allowance for income tax is £11,850. Whether or not workers between these two thresholds get tax relief on their pension contributions depends of the scheme their employer has chosen.
Members of pension schemes who don't pay income tax are granted basic rate tax relief of 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 handful of companies. It is not available for schemes that operate a net pay arrangement, which are the majority of pension funds in the market.
Latest estimates from HMRC suggested about 1.22 million workers may be affected by this issue and missing out on tax relief.
With the tax allowance rising from £11,850 to £12,500 next April, and the auto-enrolment threshold frozen at £10,000, almost half a million workers could be caught in this loophole, according to Royal London.
The Department for Work and Pensions (DWP) published its annual review of the auto-enrolment earnings trigger and qualifying earnings band for the next fiscal year today (December 4).
It stated that after considering the "latest analytical evidence and the policy objectives," the secretary of state Amber Rudd had concluded the existing threshold of £10,000 remained the correct level.
The DWP also noted that last year’s auto-enrolment review had concluded that, to date, it has not been possible to identify any straightforward solution for the problem.
However, it added the "government’s ambition for HMRC to become one of the most digitally advanced tax administrations in the world may present opportunities to look afresh at the two systems of paying pension tax relief".
According to Sir Steve Webb, former pensions minister and director of policy at Royal London, the gap between the point at which people are enrolled into a pension and the point at which they start paying tax "will become a chasm in 2019".
He said: "This means hundreds of thousands more workers will find that whether or not they get tax relief will depend on the lottery of what pension arrangement their employer has chosen for them.
"Government cannot keep kicking the can down the road on this issue. It now needs to be resolved as a matter of urgency."
Tom Selby, senior analyst at AJ Bell, said: “It is particularly cruel that this flaw in the system affects the lowest earners.
"The DWP has now passed the buck to HMRC, hoping that the shift to becoming ‘one of the most digitally advanced tax administrations in the world’ will provide a ready-made solution. But until that happens this pension tax injustice will continue."