Why lower paid employees don’t need to lose out on pension savings

Since 2012 pension scheme membership has risen from 55 percent to 87 percent of the workforce, with women and the under 30s accounting for most of this growth.

This vast improvement in retirement provision can be attributed to the success of auto-enrolment into pension schemes. Inertia has played its part in this, but the simple message that if the employee pays in four percent they can double their savings with three percent from the employer and one percent in tax relief (making eight percent), has a wide appeal.

However, for 1.3 million workers this is not the deal they are getting due to the way in which deductions from their pay are collected, leaving them missing out on tax relief. Those affected are employees with income below the personal allowance for income tax of £12,570, where scheme deductions are made pre-tax calculation, through a net pay arrangement or where salary exchange is offered. With allowances frozen until 2026 their numbers are likely to grow.

Former pensions ministers Ros Altmann and Steve Webb have campaigned for change to ensure that lower paid workers benefit from basic rate tax relief added to their pension savings. A Treasury Consultation in 2020 has so far yielded no change. It favoured moving all defined contribution schemes to relief at source (RAS). RAS gives all scheme members 20 percent relief automatically, but higher and top rate taxpayers need to individually claim marginal rate relief of 20 percent or 25 percent (21 percent and 26 percent in Scotland) from HMRC. This would likely disadvantage many higher and top rate payers as marginal rate relief is currently under claimed by those using RAS, according to HMRC.

There is a simple solution which employers and payroll can adopt now to enable all their staff to be given tax relief at the appropriate rate automatically. This is to offer the lower paid members a RAS scheme, where the pension provider collects a 20 percent credit from HMRC which is added to the members pot. Most contract-based pension providers will pre- fund the tax subsidy, so that it is automatically added to the member contribution and invested in the pension pot on the same day. Alternatively, the tax relief can be applied by the scheme administrator once received from HMRC.

Helping lower paid staff get a better deal does not need to be at the expense of the higher paid members, who get all their relief at their marginal rate when using salary exchange or net pay. A RAS scheme can be offered alongside a salary exchange or net pay scheme. Moving employees between schemes when their pay takes them above or below the personal allowance is a simple matter, aided by technology, and has been used successfully by several employers where part time working is common.