With people living longer and longer, saving for retirement is more important than ever. And to try and incentivise people to do just that, the Government currently tops up pension contributions in the form of tax relief on those contributions.
That’s a little extra each week or month to add to whatever an employee stashes away.
While this is good news for pension savers, it can add an extra layer of complexity to auto-enrolment for employers.
The wrong choice when they set up their scheme could lead to their employees failing to get their hands on a much-needed top up. This is especially problematic for lower paid workers, who could end up missing out on tax relief altogether.
“Employers don’t always realise the difference between the different ways of working out tax relief, or even know that different methods exist,” says Darren Philp, Director of Policy and Market Engagement at The People’s Pension.
“Unfortunately, the one they choose – if their scheme gives them a choice – can make a massive difference to lower paid workers, who might miss out on this valuable relief altogether when they are arguably the ones who need it most.
The confusion comes about because tax relief on pension contributions can be worked out in two different ways, ‘net pay arrangement’ and ‘relief at source’.
Under the ‘net pay arrangement’, pension contributions are taken from gross, or pre-tax, salary. The employee only pays tax on what is left after that, which means they get full tax relief straight away whichever rate of income tax they pay.
Sounds good, doesn’t it? Not entirely, because while it works for employees who pay income tax, employees who earn under the income tax threshold won’t get any tax relief at all – so won’t get that vital top up.
Under ‘relief at source’, pension contributions are taken after income tax and National Insurance contributions have been deducted. Pension providers then add tax relief to pension pots at the basic rate. This closes the loophole for lower paid workers – and higher rate taxpayers may still be able to claim additional relief back from HMRC.
“Not all pension providers make relief at source – the method which delivers the best outcome for lower paid workers – available to employers using their scheme,” explains Philp. “We actually offer both, so employers can make their decision based on the demographics of their workforce in order to best meet their needs.
“We think that all schemes should offer relief at source as standard. Tax relief makes a massive difference to pension savings, especially in the early years when money has the greatest opportunity to grow. It’s our duty as an industry to make it as easy as possible for people to access this vital top up from the Government.”
Need a solution to auto enrolment? The People’s Pension can help. Read our FREE guide to setting up a workplace pension scheme.