Govt outlines solutions for pensions net pay anomaly

Govt outlines solutions for pensions net pay anomaly

The government is seeking industry views on how to end the net pay anomaly in the pensions tax relief system which affects low paid earners.

The Treasury today (July 21) published a 40-page call for evidence which presents the options being considered to address the difference in outcomes between net pay and relief at source pension schemes, as announced at the March Budget.

Members of relief-at-source 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 HMRC will top up a net contribution of £2,880 to a gross £3,600.

But these schemes are only accessible through a handful of companies. The more common net pay schemes do not offer access to such tax relief.

To align the tax treatment for those contributing to pension schemes with the same incomes but using different methods of tax relief, the government is exploring four methods.

Method 1 - HMRC bonus

The first method involves HM Revenue and Customs (HMRC) paying a bonus to lower earners who are in net pay schemes to put them in the same position as lower earners who are members of relief at source schemes.

Under this proposal HMRC would use the current end of year process to identify those who contribute to a net pay pension scheme and have total income below the personal allowance. 

The tax authority would then provide them with a payment equal to the basic rate of tax on their contributions. 

But the government said it is “unlikely to proceed with this proposal” as it introduces additional complexity for members, pensions schemes and HMRC and there would also be a sizeable time lag between the pension contributions being made and the bonus received. 

It would also require costly administrative changes.

Method 2 - standalone charge

Another proposal was for HMRC to apply a standalone charge to recover the top-up given under the relief at source method.

This would see individuals subject to a stand-alone tax charge or the amount could be reclaimed from the pension scheme. 

The government is also against this proposal as it would mean taking money from some of those on lower incomes who are saving for their retirement.

It would increase administrative burdens on employers and relief at source scheme administrators. 

The paper stated: “Further, it would not, by itself, equalise outcomes as a [relief at source] saver would still have a lower personal allowance than a member of a net pay scheme.”

Method 3 - multiple schemes

A third option explored by the Treasury is that employers could be made to provide two schemes for their employees, one net pay and one relief at source.

Employers would switch employee contributions between schemes depending on whether their earnings would take them over the personal allowance for that pay period or not.

While the government is not keen to make this approach mandatory it said employers could voluntarily adopt a similar approach.