PensionsSep 8 2020

Can govt solve the net pay vs relief at source dilemma?

  • Explain how relief at source system works
  • Explain how net pay tax relief system works
  • Identify the key issues surrounding the government's proposals
  • Explain how relief at source system works
  • Explain how net pay tax relief system works
  • Identify the key issues surrounding the government's proposals
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Can govt solve the net pay vs relief at source dilemma?
Daniel Leal-Olivas/Pool via Reuters

However lower earners in net pay pension schemes, who are not paying tax on the element of pay from which their pension contribution is deducted, are worse off than equivalent lower earners in RAS schemes, who receive a basic rate tax top-up on contributions even though they have not paid any or much tax.

The problem is made worse because the individuals affected by it are less likely to engage with the tax system, meaning many will be unaware that they might be better or worse off under one system or the other, and even if aware, are restricted by a choice made by their employer.

The discrepancy the government is now looking to address is not new.

The difference between net pay and RAS has been ingrained in the pensions tax relief system since individuals were first given the opportunity to make contributions out of taxed earnings when personal pensions were introduced in 1988. 

However, with automatic enrolment massively boosting the number of individuals saving in pension schemes, with the increase in participation among lower earners seen as a particular success, the issue has affected more people in recent years.

The supposed anomaly has attracted the attention of prominent pension commentators and so become more visible in the national press.

This attention led to the inclusion of a commitment to review the issue in the Conservative Party’s 2019 election manifesto.

The call for evidence suggests four potential solutions to the problem, as well as inviting respondents to submit additional suggestions.

Given that some of those outcomes could result in more tax relief being paid out to savers rather than more tax collected, the outcome of this call for evidence may potentially be a little different from that of the government’s other recent publications. 

Principles

Before looking at the proposed solutions, it’s worth recognising the three principles sitting behind any change the government may introduce - simplicity; deliverability; and proportionality.

Simplicity is viewed both in terms of understanding and operation, but also in consistency of outcome for different groups of savers.

Deliverability is set in terms of taking into account the variance of tax systems within the UK; minimising impacts on savers, employers and administrators; and also providing robust, long-term solutions.

Proportionality is taken simply to mean affordability.

Let’s take a look at each of the proposals:

Option 1 – paying a bonus using Real Time Information

Real Time Information (RTI) is a system by which employers report information about pay and the personal pension contributions of their employees to HMRC. 

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