A letter has been sent to Chancellor Philip Hammond urging him to fix the tax anomaly affecting net pay defined contribution pension schemes, signed by some of the industry’s leading experts.

The letter highlighted that over a million low earners are missing out on tax relief by being in a net pay scheme, rather than the alternative relief at source (RAS) scheme. The signatories said they believe that the means by which tax relief is paid should not affect the amount of tax relief paid. Secondly, they believe savers should receive tax relief automatically, without having to ask HMRC for it.

The anomaly exists due to the way tax relief is paid on the two different type of schemes. Under net pay arrangements, the pension contribution is deducted before the tax is calculated. In RAS arrangements, the pension contribution is deducted after tax is calculated and HMRC later send the tax relief, at the basic rate (20 per cent), to the pension scheme.

The vast majority of occupational pension schemes operate on a net pay basis while traditionally contract-based schemes have operated on a RAS basis. Members of RAS pension schemes who do not pay income tax, typically those earning less than £11,850 each year, are nonetheless, entitled to basic rate tax relief on pension contributions up to £2,880 a year.

However, this tax relief is not available for non-taxpayers in net pay schemes. This means that the lowest earners in net pay schemes are having to pay 25 per cent more for their pensions (by missing out on 20p for every £1 contributed, they need to pay 25 per cent more to achieve parity).

“Many are unaware of this, but we urge you to address the situation urgently for these low-paid workers who can least afford the added cost,” the signatories told the Chancellor.
Figures from HMRC indicate that in 2015/16, 1.22 million people could have been affected by this issue – that includes those automatically enrolled as well as workers already in occupational schemes.

“Somebody earning £11,850, paying auto-enrolment minimum contributions, is missing out on £34.91 in the current tax year. By 2020/21, when the personal allowance is expected to have risen to £12,500 (and the minimum contribution rate has also risen to 5 per cent), affected savers could miss out on nearly £65 per year,” the letter noted.

Signatories of the letter include: Baroness Ros Altmann, Royal London director of policy Steve Webb, Pensions and Lifetime Savings Association director of policy and research Nigel Peaple, First Actuarial’s Henry Tapper, TUC deputy general secretary Paul Nowak, Age UK charity director Caroline Abrahams, TISA director general David Dalton-Brown, CIPP associate director of policy Helen Hargreaves and Chartered Institute of Taxation low incomes tax reform group chair Anne Fairpo.

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