Auto-enrolled low earners denied tax relief

Low earners just above the earnings trigger saving in trust-based arrangements are missing out on tax relief because their schemes operate on a net pay basis, it has emerged.

Tens of thousands of pension scheme members could be missing out on 20 per cent tax relief on their contributions because they do not pay income tax and are not in a scheme where their scheme claims tax relief for them at source. The majority of trust-based DC schemes do not operate on a relief at source basis.

The problem has emerged because of the income tax personal allowance has since April exceeded the earnings trigger for the first time. Eligible workers earning over £10,000 a year must be automatically enrolled into a scheme, but only those earning £10,600 pay income tax, meaning those earning between £10,000 and £10,600 pay no tax upon which to receive relief.

Tax relief on pensions
Tax relief on pensions

Anyone in a scheme that pays relief at source, such as contract-based schemes run by life offices, and Nest, is entitled to tax relief at 20 per cent on the first £2,880 of contributions each year, whether they have relevant earnings or not. In these schemes, the deduction is made after tax, and the tax relief is applied for by the provider. Workers earning between the £10,000 trigger and the personal allowance in these schemes are therefore not affected. But the majority of trust-based schemes are administered on a net pay basis. An individual in such a scheme earning £10,500, paying £200 a year in contributions would see £200 deducted from gross pay, which would also mean £200 from net pay, although there would be a small NI saving. This individual would never receive tax relief, even though government, regulatory, scheme and employer communications will have referred to the taxman giving £1 for every £4 contributed.

While the numbers currently affected are relatively low, the Conservative Party is aiming to raise the tax threshold so those on minimum wage do not pay income tax. This would see those earning between £10,000 and around £12,500 lose the tax relief unless changes are made.

Chase de Vere principal corporate consultant Sean McSweeney says: “Our concern is that all the main parties are committed to raising the personal allowance to around £12,500. This means increasing numbers of people will be affected by this. You also have to question how this impacts DWP communications that say the government matches every £4 you save with £1 of their own.
“This is a tricky one for trust-based schemes to sort out. Even if they get a rule change to allow them to get the relief on £2,880, they still need to administer the extra transactions needed to operate on this way. That will be a significant extra cost for them in terms of admin.”
Towers Watson senior consultant Stephen Green says: “The government looked at this when they reviewed the auto-enrolment qualification threshold. The view then was that it was better to keep the earnings trigger lower so more people would be included in pension saving. But it does mean people earning just above the trigger are not getting tax relief in certain schemes.”