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Let's talk tax relief on pensions – part two

So, following on from part one, let’s take a look at the present.

Ian     Holloway
Ian     Holloway

So, following on from part one, let’s take a look at the present.


Budget 2016 did have announcements for pensions, though possibly not the announcement that a great many people were expecting. Therefore, the EET system continues, for now. But is the current pension tax relief system really understood?


Let’s have a brief look at the two ways that tax relief on contributions is given – relief at source and the net pay arrangement. Hopefully, this will stress the importance of making sure that payrolls are set-up and administered correctly. Of all the topics I get asked about, this is one of the most common.


To start, there is a fundamental difference between the two methods of giving tax relief:


• A relief at source scheme deducts pension contributions AFTER the tax calculation has been performed.
• A net pay arrangement scheme deducts pension contributions BEFORE the tax calculation is performed.


I wonder who it was that came up with these naming conventions originally, as they just do not make sense at all!


Relief at source (RAS)


The pension contributions in an RAS scheme do not affect the calculation of taxable pay. An RAS scheme is one where pension contributions are deducted net of tax at the basic rate (currently 20%). So, for example, a net pension contribution of £80 actually means that £100 is credited to the pension scheme – £80 from the individual and £20 from the pension provider. The scheme administrators will later claim the basic rate tax relief back from HMRC.


An RAS scheme could be a group personal pension (GPP) or with The People’s Pension, if that is the option the employer has chosen. The National Employment Savings Trust (NEST) is also an RAS scheme.


All individuals will get the benefit of tax relief at the basic rate in an RAS scheme, regardless of whether they are actually a taxpayer or not. Taxpayers at the higher or additional rate can claim further tax relief from HMRC, usually via the Self Assessment tax return. This has to be done taking into account that tax relief will already have been given at the basic rate. If they don’t do this, they won’t receive the additional relief.


Net pay arrangement (NPA)


The pension contributions in an NPA scheme do affect the calculation of taxable pay. Tax relief is received at the time pension contributions are deducted, at which point the relief is received at the marginal rate of tax – 20%, 40% or 45%. In the above example, the employee actually pays £100 in pension contributions, but their income tax liability will be less as the value of their taxable pay is less (less taxable pay equals less pay on which to calculate tax).


Many occupational and all public sector pension schemes operate NPA, as do NOW: Pensions and the vast majority of master trusts.


The issue with an NPA scheme is that tax relief is only given if the individual is actually a taxpayer. If the individual has taxable pay under £11,000 in 2016-17, they will not be paying tax but may be still paying pension contributions, as the value of the auto-enrolment earnings trigger is only £10,000. So, people who are in lower-paid employments in an NPA pension scheme are losing out on tax relief through no fault of their own. If they were in an RAS scheme, their contributions would have been taken net of basic rate tax relief and would still have been grossed up by their pension provider.


NOW: Pensions recognised this and on 16 March 2016 issued a statement saying that they would make good this shortfall for the 2015-16 tax year, even though they had no obligation to do so. For 2015-16, the differential between the personal allowance and the earnings trigger was only £600 (i.e. £10,600 less £10,000).


What about the 2016-17 tax year when the differential is greater? I asked Amy Mankelow, director of communications at NOW, and she replied: “Our intention is certainly to repeat this exercise for the 2016-17 tax year. In the meantime, we will continue to lobby government departments to address the anomaly that they have created.”


Good news if you are with NOW: Pensions but will all NPA schemes be doing the same?

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Let's talk tax relief on pensions – part two Let's talk tax relief on pensions – part two
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