Providers operating “net pay” automatic enrolment schemes will be forced to abandon the model, which denies low earners tax relief, if the Government presses ahead with radical reform to pension tax incentives.
Since 2001, non-taxpayers have been able to claim tax relief on pension contributions. However, if schemes use the net pay model of paying relief, rather than relief at source, non-taxpayers do not get the 20 per cent top-up.
This is a growing problem as the auto-enrolment threshold is at £10,000 while the income tax personal allowance is at £10,600, so more non-taxpayers are saving into schemes but missing out if their employer opted for net pay.
Most occupational schemes use the net pay model and pensions minister Ros Altmann has written to The Pensions Regulator asking it to make clear to employers how employees’ contributions could be affected.
Now: Pensions uses net pay and has been in discussion with the Treasury over finding a solution. Director of policy Adrian Boulding suggests an annual “sweep” system (see Expert view). But tax relief reform, due to be announced in the March 2016 Budget, is likely to solve the problem.
Standard Life head of pensions strategy Jamie Jenkins says: “The solution put forward by Now: Pensions has potential in helping resolve the problem for earners below the personal allowance, but the bigger question is whether net pay arrangements would be viable in the event we see more significant changes to tax relief. The introduction of a flat-rate incentive, for example, would seem incompatible with net pay, where tax relief is granted at marginal rates.
“As such, it seems sensible to await the result of the Government’s review of pension taxation before making any further changes.”
The Treasury is exploring whether to flip the tax system to align pensions with Isas or introduce a flat rate of relief, the latter being the preferred choice of the industry.
Barnett Waddingham senior consultant Malcolm McLean says: “It may be that any forthcoming changes to pension taxation ease the path to a single system.”
He adds: “The solution put forward by Now: Pensions may not be appropriate for the many occupational schemes of varying sizes operating net pay – due to the burden on employers, trustees and also HMRC. In addition, any end-of-year catch-up solution poses difficulties and costs for those transferring or taking benefits during the year.”
Wingate Financial Planning director Alistair Cunningham says: “This has always been a problem, but it has become exacerbated by auto-enrolment. A flat rate of relief would give everyone the same, whether they are higher-rate taxpayers or paying no tax at all.”
We’ve come up with an end-of-year “sweep-up” idea for net pay schemes which would resolve this problem but would involve some extra work for both pension schemes and HMRC.
At the end of the tax year, the pension scheme would submit a declaration to HMRC of employee contributions received under the net pay method, showing one line per member, identified by National Insurance number and showing their total employee pension contribution during the year.
HMRC matches the pension data against P60 data and identifies employees who missed out on pension tax relief because they paid pension contributions under a net pay arrangement but received no benefit as their total taxable earnings for the year were below the income tax personal allowance.
HMRC calculates the missing relief, which will be 25 per cent of the pension contribution, but subject to a ceiling, as if the total of taxable earnings for the year and pension contributions made is greater than £10,600, then relief will have already been granted under net pay for the top slice of pension contribution that took the total above the personal allowance.
HMRC sends one payment to the pension scheme with a record breaking it down to the amount for each employee against their National Insurance number.
The pension scheme applies the payments to the accounts of each affected individual, purchasing additional units at the date of receipt of the payment from HMRC. The payment is shown on the employee’s pension plan as “tax relief for employee earning below income tax personal allowance”.
Crucially, the solution places no burden on the employer and does not require action by the employee.
Adrian Boulding is director of policy at Now: Pensions